MNI INTERVIEW: Fed To Stay Patient Given Bumpy Inflation-Groen

Federal Reserve officials will stay cautious about cutting interest rates until they gain greater conviction that disinflation is not stalling, which will not be clear until the middle of the year as growth and employment remain robust, former New York Fed economist Jan Groen told MNI.

Groen expects the Fed to begin cutting interest rates in June and deliver three rate cuts this year, but that’s predicated on a resumption of disinflation after some bumps in the road at the start of this year.

“There’s a possibility that the last mile everyone has been talking about, that might be a lot harder than we’d thought at the end of last year,” Groen said in an interview.

While Fed research has found seasonal factors tend to boost inflation in the early part of the year, a broad pick-up in services costs and persistently high wages are a source of concern that progress on inflation could be leveling off, he said. (See MNI INTERVIEW: US Inflation To Linger As Fed Loosens-Warsh)

“You can expect some firming at the start of the year because firms do a lot of repricing at the start of the year. But we saw really a broad-based firming in core services prices, both based on CPI and PPI. So I think there’s a bit of doubt there,” said Groen, who spent nearly 15 years at the New York Fed, six at the Bank of England, and is now chief macro strategist at TD Securities.

“From the perspective of the Fed it makes sense for them to be a little bit wary and just see what happens through the first quarter – whether this is a weird quirk or a first sign that maybe disinflation is petering out.”

Groen's comments after Fed officials successfully pushed back on premature market pricing of rate cuts. (See MNI INTERVIEW: Lagging Fed To Cut 100BP This Year- LaVorgna)

WAGE GROWTH TOO HIGH

Wage growth is also still too high to be consistent with price stability, he said.

“Wages are a big cost pressure for these non-housing core services. We’ve seen some slowdown but it’s still running at a very high pace compared to where it should be relative to the inflation target – still about 1 percentage point year over year basis above that,” he said.

“And if you look at three-month wage growth measures from the jobs report it actually started to firm a bit towards the end of the year. So I’m with the Fed in terms of being very cautious about what’s going on here.”

Another factor giving Fed officials pause is the strength of the economy, including a job market that continues to defy expectations for deterioration.

“June is probably where you should expect the first cut to happen, but it really depends on what real activity does,” said Groen.

If the economy keeps growing above what economists see as its potential, policymakers could hold off on cuts longer as they worry inflation might reignite. At the same time, a sudden stop in growth would drive a more aggressive easing response from the FOMC, Groen said.

“I don’t think any of that is going to become clear before the midpoint of the year,” he said.

HAPPY TO SIT TIGHT

Groen thinks officials were jolted by the market’s reaction to a dovish December decision, extrapolating from the Fed’s projection for three rate cuts this year into as many as six reductions.

“That spooked the Fed because you got quite a sudden and big easing in financial conditions right after that meeting in December. That was after three quarters of above trend growth,” he said. “The Fed is comfortable just sitting tight where they are right now and just assessing the data.”