MNI INTERVIEW: Good Chance Fed Won't Cut Rates In 2024-Plosser

Federal Reserve officials should prepare investors for the possibility that the central bank might need to keep interest rates at 23-year highs until next year because inflation might stick around 3% through year end, former Philadelphia Fed President Charles Plosser told MNI.

He said the neutral rate has likely increased significantly in recent years, which means Fed policy is currently less restrictive than policymakers believe.

“Given the strength of the economy, the neutral rate is rising. With the neutral rate rising the implicit degree of restrictiveness that’s in place becomes less and less,” Plosser said.

“I think the neutral rate could be as high as 4% now, if that’s the case the logic of the situation means the Fed is not nearly as restrictive as they think it is and therefore the opportunity for rate cuts becomes smaller and smaller. There’s already a loosening of policy because the neutral rate is going up.”

The FOMC’s Summary of Economic Projections this week showed an uptick in the median projection of the long-run nominal neutral rate, seen as a proxy for the neutral rate or r-star, to 2.8% from 2.6%. “The Fed has finally begun to take that into account.”

CAN'T RULE OUT HIKES

That means that even the prospect of another rate increase, though not a predominant possibility, cannot be ruled out, he said.

“It’s a low probability event but nonetheless a possibility that in the next six to nine months they may have to raise rates. I don’t think that’s the likely outcome, but they may have to if inflation seems to be stuck,” said Plosser, now a visiting fellow at the Hoover Institution and a member of the Shadow Open Market Committee.

“My guess is until the end of the year inflation will probably be stuck close to 3% depending on what metric you look, so I’m inclined to believe that the Fed, Jay (Powell) ought to be setting expectations that maybe rates will stay the same for the rest of the year.” (See MNI INTERVIEW: Lockhart Worries About Fed's Long Last Mile)

NO NEED TO LOCK IN FUTURE CUTS

Another thing FOMC officials should be doing is managing market expectations for how much they will cut rates after the easing process starts.

There seems to be an expectation that any initial hike will immediately lead to market to price in a much larger easing of financial conditions, which is partly why Chair Powell has referred to the first easing as highly consequential, Plosser said.

“Just because they cut once doesn’t mean they’re on a cycle to continuously cut,” he said. “They should be careful not to direct markets to think this is the first of a series.”

The central bank could catch a break on inflation or the labor market could deteriorate more quickly than expected, prompting the Fed to cut. But that is not the most probable outcome, he said.

“It’s more likely that it gets stuck above 2% and if the neutral rate really is rising they may have to put in a little more restraint,” Plosser said.