MNI INTERVIEW: Fed Might Not Be Done With Rate Hikes–Kohn

The Federal Reserve could raise interest rates further, especially if economic growth reaccelerates, in order to ensure inflation is convincingly on its way back down to the 2% target, former Fed Vice Chair Donald Kohn told MNI.

While a couple of benign recent inflation readings probably give policymakers the luxury of standing pat at their September meeting, additional increases might still be required later this year from the current fed funds level of 5.25%-5.5%, Kohn said in an interview.

“I don’t think we can prejudge November, December, but I think it’s very much on the table,” Kohn said. “The issue here is what people are calling the last mile: Inflation is down, even underlying inflation is down quite a bit, but the labor market is looking pretty tight, at least by the latest measure wages are going up pretty quickly.”

Getting inflation to target will require below-trend growth in the economy, which seems to be going in the opposite direction as consumers show resilience and even sectors that bore the brunt of rate hikes, like housing, appear to be stabilizing.

“A reacceleration of growth would be one of the upside risks to inflation. It would prejudice you toward more increases,” Kohn said. Well-anchored inflation expectations mean the Fed doesn’t need to rush to get inflation back down to 2%, but they do need to show price pressures are on a credible path lower.

GROWTH PICKUP

“Being patient about getting back to 2% is fine as long as those long-term expectations remain anchored. Being patient is more consistent with a soft-landing scenario,” said Kohn, who does not believe a recession is required to control inflation. (See MNI INTERVIEW: Odds Of Soft Landing Improved-Fed's Kliesen)

Still, the apparent pickup in activity over the past couple of months – an Atlanta Fed GDPNow estimate pegs third quarter GDP at a whopping 5.8% – is cause for concern, he said.

“If I were on the committee I’d be somewhat worried about that. That would be one of the things that would add to that sense of upside risks that they might not be on a sustainable path to 2% and would argue for, certainly not taking your foot off the brake and maybe pumping it one more time.”

Minutes from the Fed’s July meeting showed most policymakers were concerned about upside risks to inflation which they said could require additional tightening.

HIGHER FOR LONGER

Markets are now looking ahead to next week’s major policy speech from Chair Jerome Powell at the Kansas City Fed’s Annual Jackson Hole Symposium.

Last year, Powell stunned markets with a hawkish message. While he has more latitude to emphasize two-sided risks now policy has tightened substantially and is widely seen as restrictive, Kohn thinks it will be important for him to emphasize the need for not backing off of the tighter policy stance too soon.

“The risk management coming out of a period of high inflation – the risk of expectations drifting higher is larger than if you were coming out of a period of inflation around its target,” said Kohn. “It argues for making sure you don’t ease off before inflation is firmly on the path to 2%."

As officials gauge how high to keep rates and for how long, they must consider not simply the level of nominal rates against the latest inflation reading but rather tease out what real rates in the Treasury market and inflation-protected securities say about the expected path of price growth, Kohn said.

“I would want to make sure that the market anticipated that real rates were going to remain in restrictive territory for a while,” he said. “It’s a more nuanced judgment that as inflation falls we have to take real rates down.”