MNI INTERVIEW: High Inflation Points To More Fed Hikes-Lacker

The U.S. economy still faces a high risk that inflation will persist at unacceptably high levels, meaning the Federal Reserve will likely eventually need to raise interest rates further, former Richmond Fed President Jeffrey Lacker told MNI.

“The upside risks to inflation are very real, arguably the predominant risk. It could be untenable to not raise rates,” Lacker said in an interview following the release of Thursday’s CPI figures.

Lacker said policymakers and market participants were lured into a sense of complacency after a couple months of inflation reports showed price pressures dissipating.

“That’s now looking a bit transitory. It looks like the run rate is somewhere between 3 and 4-½. That supercore number is looking kind of firm too,” he said. He said conventional Taylor rules suggest real rates could need to rise by up to one or two more percentage points.

CPI jumped 0.4% in September while core rose 0.3%, leaving the annual core rate at 4.1%, more than double the Fed’s target. The data helped spark the biggest one-day spike in 30-year bond yields since the depths of the pandemic, in March 2020.

“It seems plausible that inflation either persists at this level in 2024 for longer than would be consistent with a fall to 2% in a reasonable amount of time and it also seems plausible that subsequent shocks would drive inflation up and build into wage setting rather than have it trace out a downward path," Lacker said.

HIGHER YIELDS NOT ENOUGH

The former Richmond Fed chief isn't buying a recent string of comments from Fed officials suggesting the rise in long-term bond yields is doing the central bank’s work for it, effectively acting as a substitute for additional rate increases.

“It’s not obvious that a spike in bond rates lets the Fed off the hook,” he said. “I’d find that a bit more persuasive if they’d cited falling yields as a reason the Fed needed to raise rates more, and you don’t hear that. The traditional view is that longer-term rates reflect expected future short rates and that a movement upwards could reflect an increase in the expected funds rate path. The lesson for the Fed is that it better follow through.”

In addition, Lacker said, the spike in yields is related to a very real surge in the deficit and associated Treasury issuance that the Fed cannot ignore because its longer-run inflationary tendency puts upward pressure on neutral rates.

“These large and growing deficits are having an effect and if that continues that’s going to put upward pressure on the so-called neutral real rate - R-star. If that’s true, that deficits are going to push up the neutral rate, that means the Fed is going to do more than it otherwise would rather than less,” he said. (See MNI POLICY: Lively Debate At Fed Over Possible R-Star Rise)

JOB MARKET PAIN

Neither does Lacker judge that the resilience seen in the economy and job market will necessarily make it easier for the Fed to achieve a soft landing.

“The whole mechanism by which rate hikes ought to slow down inflation is by slowing down spending growth. Instead, the economy has come in stronger over the last year or so suggesting maybe they haven’t done as much as they are going to need to, to slow spending growth.” (See MNI INTERVIEW: Credit Tightening To Crimp US Small Firm Hiring)

Lacker said stimulative U.S. fiscal policy is a "major headwind" for the Fed’s aggressive monetary tightening, which raised rates from effectively zero to 5.5% in just about 18 months.

Moreover, recent benchmark GDP revisions showed consumers have a lot more savings than previously thought, said Lacker. “That’s on top of the spending related to the Inflation Reduction Act.”