MNI INTERVIEW: Fed Sept SEP Must Reflect Rate Hike Pain-Dudley

The Federal Reserve’s next round of economic projections in September are likely to show more persistent inflation and higher unemployment to reflect the greater pain that will result from the central bank’s aggressive monetary tightening campaign, former NY Fed President William Dudley told MNI.

“This is a different message about how we have to be restrictive and we’re going to need to be restrictive for some time and there’s going to be some pain and the unemployment rate is going to have to go up,” Dudley said. “The interesting thing is will you be able to see this in the Summary of Economic Projections for September because the June projections were still quite optimistic.”

Fed Chair Powell delivered a strong and succinct message at this year’s Jackson Hole conference: interest rates will have to rise to restrictive levels and then stay there for longer. Markets reacted swiftly, with the Dow Jones industrial average diving 1,000 points with two-year bond yields rising to 3.4%, the highest level since June and edging closer to highs not seen since the global financial crisis of 2008.

And that was exactly the point, Dudley said in an interview on the sidelines of the conference.

“The more that the market internalizes the correct message from the Fed, the more financial conditions tighten and early and then the Fed has somewhat less to do,” he said. (See MNI INTERVIEW: Fed’s Harker Wants Rates Above 3.4% By Year-End)

SO LONG, SOFT LANDING

Dudley, echoing Powell’s comments, said the FOMC hasn't made up its mind about whether the central bank should hike interest rates by 75 or 50 basis points when it meets in September.

But the June FOMC's median view that rates will peak at 3.8% sometime in 2023 was still overly sanguine, he added. “My view is, 3.8% is certainly possible but I think the risks are on the higher side of that,” he said.

Additionally, the median unemployment rate in those projections went up to 4.1% which is only just slightly above FOMC officials' view of full employment, he said, suggesting the need for more slack in the economy to fight inflation.

“And yet inflation went magically down close to 2%. So it was a very benign forecast, there was virtually no pain in that forecast,” Dudley said.

“The September forecast needs to be more realistic about the pain involved and I think it needs to be more realistic about how this is going to take longer.”

Dudley said one key aspect of Powell’s remarks was that he did not try to sugarcoat possible economic outcomes.

“There was no discussion about how things could turn out to be more benign. He didn’t quite use the r-word but he talked about pain,” he said. “And that’s one of the first times he’s talking about that. Before he’d emphasized a soft landing is still possible, there’s still a path, [and] there was none of that this time.”