MNI INTERVIEW: Fed's Barkin-Prices May Force Higher Rates Peak

U.S. interest rates "may well” peak higher than the Fed has anticipated until now if inflation doesn't slow and the labor market remains tight, even as officials shift to smaller hikes to minimize the risk of overtightening, Federal Reserve Bank of Richmond President Thomas Barkin said in an interview Wednesday.

Now that real rates are credibly positive across the curve, the time is ripe for a different reaction function -- one that is more deliberate, less about speed and more about direction, he told MNI.

"Precision is an impossible standard here. Our tools work with long and variable lags, and the data are influenced by many things in addition to our tools," he said. "That’s why I like the idea of going slower for longer to a potentially higher place, because it will give you time to read the data and what you're learning from contacts and react appropriately."

Doing what it takes to curb inflation will determine the ultimate peak for interest rates, and that means borrowing costs could continue rising amid a lack of progress. "We have a choice depending on how inflation comes in, whether we pause or whether we continue to react to elevated inflation readings," he said. "If we don't get inflation under control, we may well have to keep the peak higher."

DECEMBER DOWNSHIFT

Barkin is watching for signs of cutbacks in consumer spending and capital investment -- which would presumably precede any slowdown in inflation – ahead of a decision on whether to end the string of outsized 75-basis-point hikes as soon as the Fed's next meeting in December. (See MNI INTERVIEW-Fed Set For ‘Lively Debate’ On Size Of Dec. Hike)

"I’ll be looking for signals that demand is starting to soften, and it will be wonderful to get signals that inflation is starting to soften," he said.

There are encouraging signs that some price pressures are easing, he noted. Used car prices are falling, ports are opening up and transportation costs normalizing. The October CPI report due Thursday is expected to show inflation over the past 12 months decelerating to 7.9% from an earlier peak of 9.1%, though the Fed's preferred PCE inflation measure remains near 40-year highs at 6.2%, or 5.1% excluding food and energy costs.

Yet higher interest rates have yet to have a palpable impact on prices in even the most interest-sensitive sector, Barkin said. Housing prices are "barely down" despite mortgage rates having more than doubled since the Fed began raising rates. "It takes a while for monetary policy to affect demand and a while for demand to affect prices," he said.

POST-PANDEMIC CHALLENGES

Intelligence from local businesses also points to unique post-pandemic challenges, Barkin noted. Firms in the Richmond Fed district are both reluctant to shed workers who were hard to find in the first place, and to give ground on hard-fought price increases as costs continue to rise.

"They're on Page One of the downturn playbook. They may well be cutting advertising but they're not yet in a mood to cut labor," Barkin said. "For the last 20 to 30 years, firms had a hard time raising prices. In the midst of Covid, they had the courage to raise prices and many did. They’re not going to back off cost increases until they’re forced to."

Short of older workers and new immigrants, the U.S. workforce may also be entering an era where labor is structurally short, he said, adding, "I do sense some real reluctance" to let go of workers.

As labor demand proves harder to temper, "the Fed may well have to do more,” he said.