MNI INTERVIEW: US Inflation To Linger As Fed Loosens-Warsh
Inflation could end the year well above target as the Fed cuts despite signs of persistent inflation.
U.S. inflation could end 2024 well above the Federal Reserve’s 2% target, in part because policymakers’ discussion about cutting interest rates and ending quantitative tightening has already sharply loosened financial conditions, former Fed Board Governor Kevin Warsh told MNI.
“My own view is inflation is quite likely to be well above target come Christmas time,” Warsh said in the latest episode of MNI’s FedSpeak Podcast.
Warsh said the Fed’s willingness to be dovish and signal rate cuts against a backdrop of inflation that is still too high is making its own job harder by loosening financial conditions prematurely.
“We’re trying to figure out, what’s the broad change in the constellation of prices? Is that converging on the Fed’s vaunted 2% goal. It doesn’t look like it is to me. So the Fed finds themselves in a tricky spot,” he said.
January CPI data showed a stalling of recent disinflationary progress as shelter inflation remained high and services costs stubborn. (See MNI INTERVIEW: Housing Inflation To Keep Fed Cautious-Fannie)
“If you look at the components of prices in the U.S. economy, still more than a third of those are running above 5% and that ratio is materially higher than was the case pre-Covid, and frankly it is a higher percentage of prices running above 5% than was true in 2023,” Warsh said.
The Fed has also signaled that it will likely halt QT at some point this year, meaning that any boost to the economy and markets from rate cuts will be compounded by easier policy on the balance sheet side, Warsh said.
“The Fed has shown a comfort with above-target inflation and so this inflation could prove stickier than they want. Financial conditions today are basically looser than when they started raising rates,” he said.
“By signaling such dovishness, they’re making it harder to achieve their objectives.”
BENT ON CUTS
Despite this outlook, Warsh said Fed officials appear bent on cutting interest rates this year, even if this means monetary policy becomes even less restrictive after a sharp loosening in financial conditions.
“This group seems like they want to cut interest rates. I don’t think it matters to markets quite frankly whether they cut rates two or three or four or five times. What markets care about is are they beginning an interest rate cutting cycle,” said Warsh, now a senior fellow at the Hoover Institution.
“This group thinks they can go back to some kind of status quo ante and get real interest rates that are barely positive and that’s the equilibrium,” said Warsh, who said policy is currently “not very” restrictive.
WRONG MODEL
Warsh said the Fed’s focus on wage growth means it misses the true drivers of price pressures – overly stimulative monetary and fiscal policy.
“That might have been how the wage price spiral was in the 1970s, that is not my view of how it works. I don’t think an economy that’s moving strongly and that’s paying workers is inherently inflationary,” he said. (See MNI INTERVIEW: Rising US Productivity Keeps Wages Sustainable)
The Fed still finds it too easy to shift blame for inflation away from its own conduct by attributing it to extraneous factors, Warsh said.
“They don’t use the t-word – transitory – anymore. But I hear from Fed officials references to supply chains. Well, supply chain is just a new modern word for, yeah, it really was transitory,” Warsh said.
Loose fiscal policy has also played an integral role in driving ongoing inflation pressures, he said.
“We’re more or less at full employment broadly defined yet we’re running a deficit relative to GDP higher than any point since WWII and we’re not doing it in a period or crisis or in a period of recession,” he said. “Fiscal policy has contributed in a negative way to the rise in inflation.”