MNI INTERVIEW: High Bar For Fed To Back Off Big Hikes- Athreya

The Federal Reserve should raise interest rates aggressively until there are clear signs of a slowdown in inflation, and not only in inflation expectations, Richmond Fed Research Director Kartik Athreya told MNI.

Fed officials have said getting U.S. inflation, now at 40-year highs, under control is their top priority, and Athreya said they should avoid sending conflicting policy signals.

“Inflation expectations — TIPS breakevens — are heading in the right direction, but current inflation remains above where the committee would be at all comfortable,” he said in an interview.

“Policy works when it is communicated and believed. For it to be believed there has to be routine follow through. And right now policy is not likely restrictive. All of this raises the bar for reaction to any given piece of incoming data.”

Asked what the Fed would need to see to move away from the 75-basis-point hike baseline markets now expect for at least the next meeting, Athreya said that would likely require a substantial downshift in the economic outlook. (See: MNI: Fed Sees 75BP Hikes As New Baseline-Ex-Officials)

“As a policy advisor, for me it would actually take a significant real side shock that I would see as imparting sufficient force downward to consumption growth. That would then make me think the appropriate neutral rate actually has come closer to where we currently are,” he said.

“Otherwise, while I’m not a policymaker, my instinct is the committee is not going to want to muddy the waters drastically by saying we’ve seen this or that shake out in the last data and now we’re going to appreciably change course from the normalization at a time when the inflation that is coming in continues to be well above target.”

CLEAR AND COMPELLING

Athreya said that while financial market measures of inflation expectations appeared to be easing, it was far too soon for the Fed to become complacent and not deliver on its promised hiking path, which as of the June meeting saw rates peaking at around 3.8% next year.

Five-year TIPS breakevens have fallen more than 50 basis points in less than a month, while ten-year breakevens have experienced a similar decline.

“Near-term inflation expectations seem to be getting closer to the target. If you just look at the path ahead, the committee’s policy announcements have actually had intended effects on inflation,” Athreya said.

“The Chair was super clear about inflation control and management as being a point of laser focus. I do feel like that’s been internalized very clearly by markets,” he added. “That said, if you look at ongoing inflation right now it’s not yet low. We still have headline PCE inflation that rose 60 basis points in a month, and right now the year over year rate is still above 6%.”

Core figures are slightly softer but way above the Fed’s official 2% goal.

“The year-over-year core is still almost 5% so it’s not that it’s telling a wildly different story as headline in terms of being right at target, it’s not,” he said. Athreya said he would like to see sustained month-on-month rises in the PCE and core PCE “in the right neighborhood. We are not there right now.”

He’s also keeping an eye on the long-run inflation expectations of consumers and businesses.

“The price setting that businesses and others have to engage in is presumably tied to what they think is happening to the general price level. And if that’s not in the right place you’d need to be very careful about hitting pause on the normalization.”