MNI INTERVIEW: Fed Right To Stay Open To More Hikes-Obstfeld

The Federal Reserve likely needs to see more economic weakening before officials are convinced that they can rule out further interest rate hikes – and certainly before they even begin to consider reductions in borrowing costs, former IMF chief economist Maurice Obstfeld told MNI.

“If the Fed really wants to go to 2% sustainably they will have to see some loosening in the labor market, some moderation in the growth rate. How deep that would have to be, don’t know,” Obstfeld said in an interview on the sidelines of the Kansas City Fed’s Jackson Hole Symposium.

Robust growth in the economy and employment means officials must keep their options open, he said.

“At the moment Fed officials aren’t ruling out further increases and that’s correct depending on how things develop. They’re also suggesting that there will be a holding pattern even if they don’t raise interest rates as they wait to see how the economy develops.” (See MNI INTERVIEW: Fed's Harker Sees Rates On Hold Thru Year-End)

U.S. unemployment remains near historic lows at 3.5% and job growth, while slower than the breakneck pace of late 2022, is still stronger than levels seen as needed to keep up with population growth.

“While the key indicators of labor market strength have moderated somewhat, the labor market is still historically strong on several dimensions. That raises the risk of accelerating wages feeding through to core inflation. Core inflation also remains above the Fed’s target,” Obstfeld said.

NO POWELL SIGNALS

To be sure, there are signs that growth could be slowing, including a contraction in credit, a spike in mortgage and Treasury rates as well as a moribund manufacturing sector. But a lack of conviction on the most likely path for growth is forcing officials to keep their options open – as Obstfeld said Fed Chair Jerome Powell is likely to do in his widely-awaited speech Friday.

“I don’t think he’s going to commit to much of anything,” he said.

The Fed is unlikely to consider cutting interest rates until the economy is much weaker.

“We need to see the U.S. economy slowing noticeably, to the point that the Fed views the balance of risks as being much more tilted toward higher unemployment than higher inflation. I just don’t think they’re there yet, not with this level of employment and this level of vacancies relative to unemployed workers,” he said. (See MNI INTERVIEW2:Fed’s Harker-Soft Landing In Sight, Jobs Weaker)

TREASURY LIQUIDITY WOES

Obstfeld said that the recent spike in 10-year yields to their highest level since 2007 is due in part to lingering concerns about the health of the Treasury market.

“In terms of short-term movements, Treasury markets have proven to be pretty illiquid in the past couple of years. So even if there’s no current illiquidity, the fact that markets might anticipate such episodes builds in a higher liquidity premium into the Treasury market,” he said.

“In addition we see large U.S. fiscal deficits on the horizon, increasing the supply of Treasuries – the downgrade was definitely a reminder of that.”