MNI INTERVIEW: Lockhart Worries About Fed's Long Last Mile

The Federal Reserve will keep interest rates on hold until it sees better prices data, but there are reasons to worry that inflation may be stuck in a 2.5% to 3% range, forcing the Fed to put hikes back on the table, former Atlanta Fed President Dennis Lockhart told MNI.

Most of the FOMC believe the current policy setting is restrictive and the disinflationary trend will resume before long, Lockhart said. The median policy projection from the Committee this week is likely to go down to two cuts from three in March.

"The strong bias is toward staying put until they can justify a first cut, and there’s recognition that that might take longer than previously expected," he said in an interview.

"But the inflation outlook has not deteriorated so much since March to merit a number of officials revising their rate cut forecast from three to one, so it’s far more likely we’ll see a median of two cuts."

PICTURE HOLDS

The Fed's working narrative remains little changed in the second quarter: the economy is slowing gradually but still solid, the labor market healthy and gradually rebalancing, and inflation is expected to resume its decline, Lockhart said. (See MNI FED WATCH: Awaiting Further Evidence, Keeping Easing Bias)

May data showing employers added an above-expected 272,000 jobs is likely to be viewed as a one-off and won't spook the Committee, he said. The unemployment rate edged up to 4.0% for the first time since January 2022, job openings fell more than expected in the latest reading and wage pressures continue to abate.

"The total picture is still consistent with a healthy labor market that continues to motor along and absorb people entering the workforce," he said.

Data also suggest the demand side of the economy is robust and supporting inflation at an elevated level. Final sales to domestic purchasers, a measure of consumer and business spending, stayed well above 2% in the first quarter in spite of a weaker-than-expected 1.6% headline figure for GDP, and the Atlanta Fed GDPNow forecast for second-quarter growth is currently 3.1%. (See: MNI INTERVIEW: US Growth Too Firm For Fed To Hit 2%-Blanchard)

INFLATION STUCK?

"We haven't seen second-quarter inflation numbers break markedly to the downside, so I'm looking to the fall for evidence of disinflation resuming," Lockhart said.

But if the Fed's preferred PCE inflation measure hovers around 2.7%-2.8% for several more months, suggesting the last mile is proving to be very protracted, the Committee may have to revise its view and conclude policy is not restrictive enough, he said.

"It would take a while, but that would be reason to put a hike or two back on the table and to have a more serious discussion of hikes to try to unstick the inflation trend," he said.

"We could very well -- because of the combination of wealth effects in the stock market and labor shortages and other secular trends -- settle into a 2.5%-3.0% inflation range, and I think that is a concern." (See MNI INTERVIEW: Fed Might Not Cut Rates In 2024-Andolfatto)

Fed Chair Jerome Powell and the rest of the FOMC will settle for nothing less than meeting their 2% target, Lockhart said. "With an inflation rate of 2.7%, the price level doubles in 26 years. At 2%, it doubles in 35 years. That’s not immaterial."