MNI INTERVIEW: Fed Pause Was Error, Must Hike Near 7%-Lacker

The Federal Reserve must raise interest rates a lot more in order to bring inflation back to target and this week's pause was misguided given stubborn prices, former Richmond Fed President Jeffrey Lacker told MNI.

The Fed by its own admission says key measures like core inflation and core services excluding housing are barely coming down, Lacker said in an interview Friday.

“They’re not being realistic about how high a real federal funds rate they’re going to need to bring inflation down. I think they’re going to need to go close to 7%, if not above,” Lacker, long known as a policy hawk, said in an interview.

“They’ve only brought the real fed funds rate a smidge above zero so far," Lacker said. "Powell highlighted the extent to which inflation – especially supercore– hasn’t come down, and overall core, that hasn’t come down. Pausing slows that process down and delays the achievement of that.”

Wednesday's decision leaving the benchmark rate in a 5-5.25% range follows employment and inflation data still pointing to a strong economy. And despite the rate pause the FOMC's median forecast for the peak fed funds rate was revised sharply upwards to 5.6% from 5.1%.

FED SEEN HIKING IN JULY

More upward forecast revisions will be necessary and the Fed will resume hiking in July, Lacker said. “My guess about the committee dynamics is that the burden of proof is on those who want to pause,” he said.

“Pausing accompanied by continued persistence of core inflation is at some point going to force them to revise their policy guidance upward and raise rates further. You’d think they want to get it over with this year,” Lacker said, in part because tightening in 2024 will garner more scrutiny during a presidential election year.

U.S. CPI fell to a two-year low of 4% in May but core CPI, which excludes food and energy, was still 5.3%. Both measures are far above the central bank’s official 2% goal.

Worries about a credit crunch due to regional banking stresses were misguided, Lacker said, because that sort of lending contraction should be part of the monetary tightening process.

“Concerns I’ve read about additional disinflationary impetus from the credit channel strike me as overblown,” Lacker said. “When the Fed raised rates in the past to stymie inflation it generally gets them banking stress along the way.”

INVESTORS UNDERPLAY JOB PAIN

One risk investors aren't taking seriously enough is pain coming in the labor market as interest rates climb further, Lacker said.

“It’s hard to see them slowing spending without an imprint in the labor market," he said. "Whether that imprint is soft and can skirt the boundaries of setting off a downward spiral or not is an open question,” he said.

“The market seems quite sanguine but I think it’s premised on the idea that the Fed hasn’t done enough and isn’t going to to enough.”

The key lending rate hasn't been around 7% since the central bank began a series of cuts coming out of the deep recession of the early 1990s. Chair Jerome Powell said Wednesday most officials see the need to go further but for now they need to assess the drag of its past tightening.