MNI INTERVIEW: Fed’s Wright Optimistic On Further Disinflation

A further drop in inflation should allow the Federal Reserve to stop raising interest rates soon but signs of stalling in that progress could also prompt additional central bank tightening, St. Louis Fed Senior Vice President Mark Wright told MNI.

“I’m cautiously optimistic that the disinflation will persist and that we gradually glide down to our 2% target. I’m also extremely confident that if the data come in suggesting that we’re not going to do that, then the FOMC will make an appropriate adjustment to ensure that we’ll do so,” Wright said in an interview.

The hawkish shift in the Fed’s estimates for the path of interest rates represents in part a desire to ensure that financial markets do not unduly loosen financial conditions by prematurely pricing in rate cuts, he said.

“Interest rates are at a level to be moderately restrictive which is appropriate for the economic state of affairs,” he said.

ABOVE 5% THRU 2024

Policymakers left the federal funds rate in a 5.25%-5.5% range at last week’s meeting but penciled in one additional quarter-point increase for 2023 and reduced the number of cuts for 2024 to just two from four.

“One of the reasons why forward guidance is so important is because it’s more likely to influence those medium longer-term rates that matter for decision making,” said Wright, who is also former research director of the Minneapolis Fed. “That’s what we’re trying to signal, and we’re prepared to back that up, as the SEP shows." The median FOMC member expects short-term interest rates to be above 5% at the end of next year.

"We certainly want to avoid a situation in which market expectations for rate cuts are so strong that the interest rates that households and businesses look at fall, that would tend to stimulate the economy when we might need to restrain it a little bit.”

SOLID CHANCE OF SOFT LANDING

Wright said the economy’s strength despite the Fed’s historic tightening campaign is a sign that policymakers have a good chance of engineering a vaunted soft landing.

“The fact that the economy has proved quite resilient despite a very significant spike in interest rates and at the same time inflation has come down is really very good news,” he said. "It leads me to be a lot more confident that we’re going to be able to have a soft landing, with inflation returning to 2% without unemployment rising by very much. That’s what’s reflected in the SEP too.”

The prospect of a pause in rate increases means that for now banks should not be too worried about the spike in 10-year Treasury yields to 16-year highs, he added. The banking system is sound and resilient, while the bump in yields is due mostly to higher real rates, not rising inflation expectations.

“What I take confidence in is that the inflation expectations, as revealed by the comparison between Treasuries and TIPS, still remain very well anchored in the neighborhood of 2% over that horizon,” Wright said.

“The 5-year/5-year forward is just a touch above 2% which, allowing for the fact that it’s based on the CPI and not the PCE, is very much consistent with 2% or slightly below 2% in the PCE number.”