MNI INTERVIEW: Fed To Resume Hikes Later If Inflation Lingers

The Federal Reserve is likely to pause its interest rate hikes after the next meeting but would not hesitate to restart them later in the year if inflation proved more persistent than officials expect, former Richmond Fed research director John Weinberg told MNI.

“If the economy keeps chugging along and the Fed pauses but disinflation doesn’t continue then I would expect they would return to further increases,” he said in an interview.

For now, the Fed looks increasingly inclined to pause as it takes stock of the cumulative effect of more than a year’s worth of rapid rises in official borrowing costs, and as policymakers gauge the possible drag on credit from the recent turmoil in banking.

“There certainly seems to be a wait and see sentiment arising in some members of the committee,” said Weinberg.

That could lead to some changes to the statement which don’t necessarily promise a pause but signal officials are less eager to keep hiking.

“They’re trying not to lean too heavily into forward guidance, but subtle changes in language that suggests they’re less antsy – these days that would count,” he said. “On the face of it inflation is still too high so they’ve got to continue to express the intent of bringing it down. A pause isn’t really about backing off of that intent.”

NOT REALLY RESTRICTIVE

Weinberg said monetary policy is not yet truly restrictive despite the Fed’s assurances that it would like to raise rates to “sufficiently restrictive” levels in order to return inflation back to its 2% target.

This week’s first quarter GDP report included a strong reading for core PCE inflation of 4.9%, up fairly steeply from the fourth quarter’s 4.4%. The monthly PCE reading Friday showed core PCE rising 4.6% on the year, still well more than double the 2% target.

“You’ve got to pick a way to take off an inflation measure from nominal rates to what you think the real rate is right now. Thinking about the funds rate, the short-end of the real curve – the inflation you want to subtract is the trend right now,” Weinberg said. (See MNI INTERVIEW: Inflation Could End 2023 Circa 5%-Fed's Gascon)

“Historically the best readily available measure of that in real time is something like three-month core, and most of the decline in headline inflation in recent months has been dominated by non-core elements so if you do something like that then real funds rate is still looking kind of around zero. That doesn’t feel that restrictive.”

The fact that inflation has been high for as long as it makes it harder to bring down, said Weinberg, because expectations tend to become more embedded at higher levels.

“If inflation expectations have become anchored, at least medium, at something higher than the Fed wants them to be, then I don’t know how much a weakening economy would add to disinflationary forces,” he said.

SOFTISH LANDING

Weinberg said rising concerns about a possible recession later in the year are justified given the combination of a credit tightening that was already under way due to higher interest rate policy, potentially compounded by the banking sector’s troubles. But he said contraction is not inevitable.

“The window for a soft landing is getting smaller. I wouldn’t say it’s entirely closed,” he said.

He sees market expectations for rate cuts not long after the fed funds rate reaches its cycle peak as based in part on more pessimistic expectations for the economy on Wall Street.

“The market is more pessimistic about the real economy than the Fed on balance. Maybe that’s enough to explain that gap,” he said.