MNI INTERVIEW-Fed Set For ‘Lively Debate’ On Size Of Dec. Hike

Federal Reserve officials may clash at the December meeting over whether to slow the pace of interest rate hikes despite persistently high readings for key inflation measures and a strong job market, former Richmond Fed research director John Weinberg told MNI.

“That’s going to be a lively discussion in December,” he said in an interview with MNI’s FedSpeak podcast following this week’s FOMC decision to raise interest rates by 75 basis points for a fourth consecutive meeting.

“There’s likely to be a number of committee members who think that even with the picture that we have now, as long as rates continue going up and are moving toward a sufficiently restrictive stance, that they can afford to slow the pace. So I wouldn’t be surprised to see them do that.”

Fed Chair Jerome Powell in his press conference this week emphasized that while the Fed is considering slowing the pace of hikes in the next meeting or two, that will likely mean a higher terminal rate than the 4.6% priced into the September SEP.

The FOMC also emphasized the need to make monetary policy “sufficiently restrictive” to bring inflation down from near 40-year highs back to the Fed’s 2% target.

“The real policy rate needs to be positive, it’s not now,” said Weinberg. “Inflation is falling more slowly than the committee had hoped, which means that by the time they get up to a nominal rate of say 4-½%, if inflation hasn’t cooled as much as they had expected, then the stance of policy is not going to be perhaps restrictive at all and maybe not sufficiently restrictive.”

He said that given current conditions rates are likely to peak around 5% as markets expect but the range of outcomes is wider than usual. (See MNI: Ex-Officials Now See Fed Rate Peak At 5% Or Higher)

UNDERLYING MOMENTUM

Echoing arguments from some Fed officials that the economy is strong enough to withstand the central bank’s aggressive tightening campaign, Weinberg said a recession may yet be avoided, and, if there is one, it would not be particularly deep.

“Even if monetary policy gets restrictive enough to contribute to some actual contraction in the economy, the economy is positioned to weather a policy shock like that and perhaps other typical real shocks,” he said.

“Household financials are in reasonably good condition, there's still some fiscal impetus in the pipeline, and all of these things should mitigate any recessionary effects on the economy. So I think if there is a recession in the next couple of years it will be pretty mild.”

The October jobs report out Friday corroborated that momentum, with the economy generating a stronger-than-expected 261,000 new jobs.

Still, Weinberg conceded that high uncertainty around prices means the Fed may yet face the challenge of entering a recession while inflation is still well above target.

“If we actually get recessionary forces emerging in the real economy, whether it’s caused by monetary policy or some other shock then the problem gets a lot trickier, because the committee’s tendency will be to want to provide accommodation in the face of significantly rising unemployment,” Weinberg said. “And if inflation hasn’t fallen sufficiently by then you could get into a ratchet problem which everyone wants to avoid.”