MNI INTERVIEW: Fed Should Hike 50BPS If Data Stay Strong-Kohn

The Federal Reserve should keep open the option to revert to a 50-basis-point rate increase in March if upcoming data on jobs and inflation corroborate a burst of strength early this year, former Fed Vice Chair Donald Kohn told MNI.

“If it turns out that January wasn’t an outlier and the data that they have for February confirm or at least don’t undercut the January resilience in both prices and activity, then they need to be open to larger moves, at least one larger move,” Kohn said in an interview.

“I’m guessing they don’t want to make 50 the baseline – keep 25 as the baseline but when the data come in that suggest they’ve falling a bit further behind where they thought they would be” the Fed might act more aggressively.

Markets have sharply repriced the peak fed funds rate up to around 5.6% after a strong streak of economic data and hawkish testimony from Chair Jerome Powell this week. Investors and Fed officials will be scouring reports on jobs Friday and CPI Tuesday for clues as to whether the recent strength proves persistent. (See MNI INTERVIEW: Fed Likely Needs To Move Rates Above 6%-Mishkin)

DIFFERENT PICTURE

“He had to acknowledge that the data had shifted pretty dramatically in January including revisions to past data which gave a different picture of underlying trends,” Kohn said. “The point of downshifting to 25 was to evaluate incoming data.”

The Fed stepped down the pace of hikes to a quarter point in February but the hot run of economic figures – and now the official suggestion from Powell – have reopened the door to a half-point move.

“Looking at their preferred measure of inflation, services ex-housing, we’re not making any progress on that and only modest progress on the wage front feeding into that – and labor markets remaining very tight,” Kohn said.

Kohn, whose career at the Fed spanned some four decades, said he’s not sure how high rates will have to go to become “sufficiently restrictive” to completely root out inflation pressures, but he says there is likely to be an upward revision to the Fed’s SEP forecast for the fed funds peak.

“The last SEP, almost half the people wanted it higher than what the median was so the median was not representative of the central tendency,” he said.

“It wouldn’t take much to bring that median up at least 25 and maybe 50 basis points depending on how many people shift how high.”

Still, he warned that “whatever they put down will be just an estimate, a projection that’s subject to revision, that’s the point here. They’re in a phase in which the incoming data will help them determine how high they need to go and how fast they need to get there.”

‘THE PLANE HAS TO LAND’

Kohn rejected recent market speculation over a “no landing” scenario where the economy simply maintains momentum despite aggressive Fed tightening.

“That’s not going to work, that’s not going to get inflation back into the three range. So there has to be a landing. Certainly, the resilience of the economy and of prices early in 2023 mean they raise to raise rates more,” he said.

That doesn’t necessarily mean the economy is bound for recession, however.

“I think they need to slow growth quite substantially, well below potential, vacancies need to start dropping, the unemployment rate probably needs to rise at least some in order to take pressure off,” he said. “The plane needs to land. That said, I don’t entirely get why the tighter policy implies more chances of a hard landing.”