MNI INTERVIEW: Fed’s Athreya-Upside Risks To 4% Inflation View

The surge in energy prices could mean inflation more than doubles the Fed’s target this year, Richmond Fed Research Director Kartik Athreya told MNI, adding that it would still make sense to await further clarity on the war in Ukraine before tilting towards more aggressive rate hikes.

“If we look at year-on-year inflation I would expect something around the 4% mark for this year,” he said in an interview, referring to the Fed’s preferred PCE measure. “That’s my baseline. But I think the risks are to the upside at least for the next year.”

“If the war continues to be protracted and world energy markets are significantly hampered, that is going to show up in U.S. prices,” he said.

Still, Athreya said he’d prefer to await more clarity on the geopolitical outlook before favoring more aggressive interest rate hikes like the 50-basis-point moves suggested by a number of officials in recent days.

“It’s possible that near-term uncertainties that loom kind of large right now may actually resolve themselves pretty substantially and then leave the door open for more aggressive policy if that’s what is seen as right for the committee,” he said.

Fed Chair Jerome Powell and others have indicated the committee is strongly weighing a 50-basis-point move as early as May. St. Louis Fed President James Bullard dissented in favor of such a move this month, when the Fed raised rates by a quarter point.

U.S. inflation has exceeded Fed officials’ worst fears, hitting 7.9% in the year to February, a 40-year high.

'FAIRLY UNPRECEDENTED'

Athreya said that while there’s some comfort in still-tame readings for longer-run inflation expectations, rises in short- and medium-term expectations, coupled with persistently high headline readings, raise the risk of expectations becoming unanchored.

There have been “successive inflation prints that are fairly unprecedented for people – there are some who haven’t seen these kinds of prints in their adult lives – 8%, 10% in CPI is something that people haven’t really seen.”

The fear of losing control of expectations has underpinned a sharp pivot in Fed policy toward a much more hawkish stance as expressed in its latest Summary of Economic Projections.

“The committee has made very clear in its public utterances that this is actually a really important priority right now. We have a dual mandate, but it’s very clear right now that the inflation is the thing that needs direct and quick attention,” Athreya said.

SOLID GROWTH MOMENTUM

The economy has plenty of momentum to absorb the Fed’s expected tightening path, which showed a median of seven interest rate hikes for this year, according to the Richmond Fed economist. He said the prospect of yet another mini-boom in services as Covid shifts further into the backdrop should offer a further boost.

“That makes me think about GDP growth numbers that are fairly robust. For 2022 a 3% print wouldn’t surprise me for the 12-month growth rate that we clock at the end of the year,” he said.

“It’s because of that rebound that I think those numbers are actually possible even in a policy landscape that is moving toward removal of accommodation.”

Nor does he expect a major hit to growth from the latest energy shock.

“I’m more optimistic that we’ll continue to weather that. We continue to become a less energy-intensive economy and we also have a very significant energy exporting sector.”

The recent rise in bond yields reflected a healthy digestion of the Fed’s messaging, Athreya said.

“I think policy having moved quite sharply, if you just even look at the SEP, and you’ve seen the 10-year now …. these things indicate policy normalization is clearly under way by a committee that is cognizant of the priority that inflation has now.”