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Building price pressures could force the Federal Reserve to raise interest rates next year, well before its latest projections indicate, ex-Kansas City Fed President Thomas Hoenig told MNI, adding the central bank feels under pressure to maintain a dovish stance.
"To think that you wouldn't have a move until 2023 to me is almost not credible," said Hoenig in an interview. "Conditions might be such that the market may force them. If inflation continues then bond yields will begin to rise again."
The Fed surprised markets this week with a shift in officials' projections for rate increases that was more hawkish than the March forecasts and more aggressive than most participants had expected given previous Fed messaging. While the shift toward a median 2023 liftoff in interest rates to as high as 0.6% from their near-zero levels unnerved investors in itself, the transition of so many dots into 2022 and 2023 also showed just how quickly rate views can change based on a couple of months of data.
"The dots are short-term in nature -- people change their views based on the most recent data," Hoenig said.
The Fed was until recently convinced that inflation might spike for a couple of months and would quickly come back down to its 2% target. But after two months of readings well above forecast, including a CPI print of 5% for May, the Fed has conceded its preferred PCE measure will run hot at 3.4% this year.
"If inflation gets really wild you're going to have to really accelerate and then that's going to be huge -- that's a Volcker move," Hoenig said. "Here you have a chance to avoid it but they're not going to upset the apple cart."
THINK ABOUT IT
The Fed's reluctance to even entertain the debate about tapering its monthly USD120 billion in bond buys before this week's meeting is a sign of strong political and market pressures against any policy tightening, Hoenig said.
Until Wednesday, Fed Chair Jerome Powell had repeatedly stated officials were not even "thinking about thinking about" reducing QE.
"I really do think there's a concern about upsetting the market, I think there's concern about upsetting the Congress, there's a concern about upsetting the administration," said Hoenig. "It doesn't make sense. This is the job and they're going to say, we're not going to talk about it?"
Hoenig said the shift toward a more active fiscal policy under the Biden administration, which has already delivered USD6 trillion in support and is now pushing a broad infrastructure package, has significantly altered the economic outlook. But the Fed has stuck to its new, more dovish policy framework and made too few adjustments to its rhetoric about possible inflation risks, he added.
"They're waiting to be forced to do something. And if you wait, you're always going to be reactive, you're always going to be behind the curve," he said. "I'm worried about inflation, yes, but I'm also worried about the continued misallocation of resources that's going on."
'HELL OF A JOB'
The size of the budget deficit makes it inherently more difficult for the Fed to reduce its bond purchases, Hoenig said, raising concerns about fiscal dominance.
"If you start to taper when that stuff is coming up, interest rates are going to go up," he said. "Tapering is going to be one hell of a job to get done."
In addition, employment has not picked up as quickly as Fed officials had hoped earlier in the year, when Powell talked about wanting to see a string of monthly job gains around the 1 million mark after March showed 916,000 new hires. Since then, the March reading was revised down to 785,000 while April came in at just 278,000. May jobs rose 559,000.
Hoenig said this points to deeper problems of labor mismatch that could take a while to resolve but have little to do with borrowing costs.
"If employers are seeking 9 million openings and you're filling only 500,000 a month, that's a structural problem that I don't think monetary policy can fix," he said. "So if you wait for that to come down you're going to have a lot of inflation before it does."