MNI INTERVIEW: No Fed Cuts Until H2, Ex-KC Fed's Hoenig Says

The Federal Reserve's monetary policy stance might not be all that restrictive given persistent economic strength, suggesting the central bank will stay cautious about cutting interest rates for longer, likely into the second half of the year, former Kansas City Fed president Thomas Hoenig told MNI.

"They're restrictive but only moderately so and inflation is coming down but it's coming down much more slowly now," he said in an interview. "We've come off a year in 2023 that was stronger than anyone anticipated and even coming into this year the first quarter looks to be good."

Hoenig said the Fed may not be as restrictive as thought because the natural rate, or r*, may be considerably higher than some policymakers -- at about 2%. "If you take that 2% kind of equilibrium rate and add 2% inflation, a nominal rate consistent with steady, stable growth and low inflation is around 4%," he said. But when considering that today's inflation around is around 3%, "then the Fed's roughly 5.3% funds rate, it is only really moderately restrictive, by 30 basis points or so."

MODESTLY TIGHT

"Monetary policy is only modestly tight," said Hoenig, who led the KC Fed for 20 years. By contrast, officials at the FOMC have penciled in a median natural rate of 0.5%.

"If the inflation numbers don't come down and stay down through June and maybe August, then it would be a mistake to lower rates because it would re-ignite inflation," he said. Hoenig downplayed chances of three rate cuts this year starting in June and pointed to communication late in 2023 that eased financial conditions and buoyed growth.

But when the Fed does ease, they should ease carefully and watch how the economy reacts, he said. "They shouldn't ease dramatically at every meeting." (See: MNI INTERVIEW-Fed Could Cut Fewer Than 3 Times In '24-Friedman)

The Fed has been on hold for eight months, nearing the historical average time between the last hike in a tightening cycle and the beginning of easing, he said. That suggests pressure from markets and politicians will continue to mount on the central bank. "They better wait and make their judgments cautiously."

BANKING SYSTEM

The banking industry remains more fragile than regulators are letting on, said Hoenig, a former vice chairman of the Federal Deposit Insurance Corporation from 2012 until 2018. "There is vulnerability but that doesn't mean we'll have a larger problem. We may get through it and repricing may take place, but at the same time you could see a larger issue."

Policymakers "better pay attention because you have a lot of banks that still have underwater securities and underwater loans on their books that if they would have to be repriced in a hurry, we'd have a problem. That's why you see the Fed providing all kinds of other types of liquidity for those institutions."

Hoenig celebrated regulators' recent "catching up" of putting greater focus on the Fed's discount window, but noted the focus should have been there earlier before the Fed raised interest rates by 525 basis points. He also said officials need to take a look at Federal Home Loan Bank pricing relative to the Fed's discount window. (See: MNI INTERVIEW: Fed Should Mandate Readiness Of Discount Window)

"When you look at that yield curve, and it's upside down, there's a real possibility of liquidity stress, so I hope they're doing what they should be doing. That's what really is a major responsibility of a central bank."