MNI INTERVIEW: Fed’s Harker Says Probably Time To Stop Hiking

The Federal Reserve is bringing inflation gradually back down to target, and it’s probably time for officials to consider leaving interest rates on hold until at least early next year, Philadelphia Fed President Patrick Harker told MNI Thursday.

“We can hold steady for a while because we are clearly in a restrictive stance in my view. We can sit here for a while, let monetary policy continue to do its work,” he said in an interview on the sidelines of the Kansas City Fed’s annual Jackson Hole Symposium. “Inflation is not where we want it to be, but it is moving in the right direction.”

He said it’s too early to start discussing rate cuts, but the time will come when the economy is ready for them.

“At some point we’re clearly going to adjust rates lower. I just don’t see that happening until at least the beginning of next year, maybe even after that,” he said.

The Fed raised rates aggressively over the last year-and-a-half, from effectively zero to a 22-year high of 5.25-5.5%. Inflation has come down to a 3%-4% range, from a peak above 9% last summer. Policymakers are debating whether additional increases are needed, with Harker clearly in the more dovish camp believing the fastest rate hikes since the 1980s are doing enough to contain price pressures. (See MNI INTERVIEW: Fed Might Not Be Done With Rate Hikes-Kohn)

RESTRICTIVE TERRITORY

Banks and businesses in the Philly Fed district are clearly feeling the effects of higher interest rates, which Harker said are being reinforced by a spike in long-term Treasury yields.

“By having that rise in the 10-year (yield) it is tightening financial conditions, and we’re hearing this. I’ve been out and about in my district talking to people and they’re clearly seeing some contraction in credit as part of this,” he said.

Banks are focused on serving existing customers but have become much more stringent about new loans, he said.

Harker was not overly worried that a strong economy and labor market would prevent the Fed from returning inflation to its 2% target over time. “It’s not a bad thing if we’re seeing growth and we’re seeing inflation come down. On the labor market, that’s a healthy sign that you’re still seeing labor demand,” he said.

QT COULD END

The continued shrinking of the Fed's balance sheet offers another channel through which financial conditions are tightening, Harker said. “We have both the tightening that’s happening as we hold at the higher rate and the reduction of the balance sheet, which should continue to remove financial accommodation and help bring inflation down.”

However he was skeptical of the idea that the Fed should continue allowing its assets to mature without replacing them after the FOMC begins cutting rates. Fed Chair Jerome Powell suggested the Fed could consider such a move last month.

“My preference right now would be to not cut rates as we are continuing the quantitative tightening. I think it is a bit confusing. But there may be circumstances where that is appropriate to do, we’ll just have to see,” he said.

NO CHANGE IN R-STAR

Harker also weighed in on a debate that has been a keen focus for markets – whether the neutral rate of interest or r-star has risen, which might imply that nominal interest rates might also need to be higher than in the past.

“At this point we still think it’s around 0.5%. Adding 2% inflation, in the long run you get to 2.5%. Because that’s where it was before. So the question I keep asking myself is, what has the pandemic done that has fundamentally shifted the American economy, the global economy?” he said.

“A reasonable hypothesis is, not much has changed. Yes, the relationship with China is different, supply chains have shifted, and AI is coming. But has any of that fundamentally shifted r-star? I don’t know the answer to that but at this point I’m leaning toward saying not a lot.”