MNI INTERVIEW: Fed To Keep Options Open Amid Risks - English

MNI (WASHINGTON) - Risks to the Federal Reserve's inflation and employment objectives are tilting further to the downside but remain quite balanced, so the central bank could go either way as it weighs whether to cut interest rates by 25 or 50 basis points this week, former director of the Fed Board's division of monetary affairs William English told MNI.

"In recent months, the inflation data have been pretty good, so inflation seems to be more or less on track, but the labor market's been softer, particularly with the revisions," he said in an interview Friday. "The outlook is for an economy that is just a little bit weaker than I thought a few months ago."

"I've shifted just a little towards thinking there are bigger risks to the downside here, but they're still fairly balanced," he said.

Rates have been at a 23-year high of 5.25-5.5% since July last year and the Fed last lowered them in March 2020, when they reached the zero lower bound during the pandemic. Real rates are the highest in decades and only moving higher as inflation ebbs, lending itself to the argument that the Fed can begin easing policy, English said. 

KEEPING OPTIONS OPEN 

"It's a hard call right now, and it depends on the balance of risks, and it depends on judgment, and it is not obvious exactly how they're going to come out," English said of the upcoming FOMC meeting. Futures traders see a nearly 50% chance the Fed will start its easing cycle with a 50-basis-point cut.

"It probably is helpful for the FOMC to have markets kind of balanced that way. They really can have a discussion and make their decision, and it's not going to be a huge surprise, either way,” he said.

"It's the first meeting in a long time that is genuinely uncertain," he added, noting that the Fed could cut by between 75bp and 125bp through the end of the year.

"It really does come down, in this case, to a sense of the balance of risks. Do they feel that there's a significant risk that the economy just slows, and so they want to try to head that off, or they're more comfortable that the economy is more or less solid?"

Such uncertain market pricing so close to the meeting  also presents risks for the Fed, English said. If it cuts by 25 basis points against expectations for 50 then there could be a "significant tightening in financial conditions," but also if the central bank cuts by 50 basis points then that could set expectations for a dash to neutral and that could be a "big easing” of financial conditions.

"The way you deal with either of those risks is with your communication around the decision in the statement and the SEP," he said. "They'll be trying to say: 'Don't read too much into this. It's just one decision at one meeting.'"

There is an increased chance that officials dissent, he said.

"I'm wondering if there won't be a dissent. We haven't had a dissent in a long time, but this is a situation where there could be a dissent. People just have different assessments of the balance of risk, and want to say so."

LABOR MARKET 

Whatever this week's decision, the Fed is likely to take rates to 3% over the next year or so, said English, now at Yale University. "The risk here is that something hugely surprising happens," he said. "The more likely surprise would be the economy really does slow."

A 4.5% unemployment rate at the end of the year seems plausible, said English. (See: MNI INTERVIEW: Balanced Risks Call For Gradual Cuts - Lockhart)