MNI INTERVIEW: Fed Likely Done With Hikes Despite Hawkish Tone

The Federal Reserve is probably done raising interest rates as the central bank's higher-for-longer message gains traction and long-end yields do the central bank's work for it, said former Fed staffer Jonathan Wright, who sees a 25% chance of more hikes in December or early next year.

"I would expect the Fed to stand pat at the next meeting and they will point to financial conditions as having effectively delivered some tightening already," said Wright, a former member of the Fed Board's division of monetary affairs and the co-creator of the Kim-Wright term premium model.

That model shows the term premium on a 10-year Treasury is up more than half a percentage point since the start of September. "The factors that will drive the term premium up would be things like uncertainty about neutral real rates, the sheer amount of treasury issuance, the Fed's QT, and maybe the fact that banks aren't being encouraged to hold long term government bonds anymore as much," he said. (See MNI POLICY: Lively Debate At Fed Over Possible R-Star Rise)

UNRELIABLE

"It's pretty unambiguous that the higher term premium is going to cause not just Treasury yields, but all long term bond yields including corporate, including mortgages to be higher, and higher for reasons over and above the expected path of monetary policy," he said. "That slows growth and that slows inflation. It's easily done more than one 25 basis point hike to have that rise in 10-year yields."

Fed officials have welcomed higher term premia and suggested it could mean less need for rate hikes but have suggested the rise in long-term Treasury yields can't be relied upon in providing policy guidance.

It's perfectly possible that the term premium could turn and go straight back down, which would then run the risk of reigniting inflation, Wright said.

"The way Powell will come out on this is to at least leave himself open the option of further rate hikes maybe as early as December, and one of the things that would push him in that direction would be an easing of financial conditions."

"I can certainly see ways in which they would start up again in December, maybe even next year, but I would give that maybe 25%," Wright said. "The more likely scenario is that they are done." The Fed last raised the fed funds rate in July, reaching its current range of 5.25% to 5.5%.

WILLING TO WAIT

But Wright said that would likely leave the Fed missing its 2% inflation target. "I don't think they've done enough to get core inflation reliably down to two, but I think they've done enough to get it into a range where the risk of a hard landing outweighs the benefit of getting inflation down all the way right away." (See: MNI INTERVIEW: Disinflation Stall Could Push Fed To 6% Or More)

"The question is does the Fed want to go the last mile to get inflation all the way down to 2%? And my view is in rhetoric the answer is yes. But in reality, the answer is probably not. They're willing to wait for an opportunistic disinflation but not tighten policy further to get it down to 2%." (See MNI POLICY: Fed To Consider Shift To Inflation Target Band)