MNI INTERVIEW: Reasonable For Fed To Slow Pace Soon - Quarles

The Federal Reserve could step down to a slower pace of rate increases in December and it may not need to do much more to constrain inflation, former Fed Governor Randal Quarles told MNI.

It "would be reasonable" to slow the pace of interest rate hikes in December, Quarles said in an interview, pointing to debt levels that have built up over the last 15 years that may mean interest rate increases now have a greater impact.

"Any given nominal increase in interest rates is going to be a huge percentage increase in the cost of debt service," he said. "So the constraining effect of any given increase in nominal rates is greater than it has been in previous tightening cycles."

Federal borrowing from the public as a percentage of GDP has increased from 35% in 2007 to 97% of GDP at the end of fiscal year 2022, while corporate debt has roughly doubled.

"I think that a terminal interest rate of 4% or moderately more will be enough to actually constrain this inflation," said Quarles, who was among the first Fed officials to adopt a more hawkish stance in October last year when he warned of significant upside risk to inflation.

"I do expect that we'll see inflation start to moderate materially between now and into January," he added.

The Fed laid out a path in its September SEP to a peak funds rate of 4.6% next year. Fed officials are expected to raise the fed funds rate 75 basis points next week and potentially debate a smaller increase in December.

SHORTER LAGS

Some officials have noted the potential for a higher peak and some have noted a preference for dismounting to a slower pace later this year. Ex-officials have told MNI inflation persistence may make it harder for the U.S. central bank to slow down later this year. (See: MNI: Ex-Officials Now See Fed Rate Peak At 5% Or Higher)

"It's going to be hard for it to judge when it has done enough, because the traditional macroeconomic relationships are going to be different this cycle," said Quarles, a former Fed vice chair for supervision and chair of the Financial Stability Board.

Quarles added that the Fed will not pause its rate hiking cycle until there is more improvement on inflation. "I think the majority of the committee is not going to want to do that until they're sure inflation is under control. You would need to see some really significant moves in the labor market in particular," he said.

Adding to the difficulty is the lag from monetary policy to real activity, which Quarles said could be shorter than normal due to Fed communications.

Earlier this month, Fed Governor Lisa Cook said less of a lag may exist now between rate hikes and the tightening of financial conditions, and Vice Chair Lael Brainard said in some sectors lags in transmission mean that policy actions to date will have their full effect on activity in coming quarters.

"You're still going to see a several month time lag between any action and it's affecting the economy," Quarles said. "So we're really only now beginning to see the effects on the economy."