MNI INTERVIEW: Fed's Daly Downplays Chances Of 50 BP Rate Hike

San Francisco Federal Reserve President Mary Daly told MNI Thursday interest rates will almost certainly rise beginning in March followed by at least two more hikes this year, but downplayed the need for a half-point increase at the upcoming meeting despite another stronger-than-expected reading on inflation.

“My own view is that March is the live meeting when we would raise interest rates for the first time, and I could imagine raising at subsequent meetings as well, but I just want to see the data,” she said in a phone interview.

“While I'm able to say a modal outlook of three rate increases and balance sheet reduction starting later this year, you know, I could easily imagine myself saying that more is needed,” she said, adding the uncertain economy makes it harder to give firm projections.

Sending a stronger signal with a half-point rate hike “is not my preference” Daly said, given the lingering drag of the pandemic and because the Fed is already sending a clear message to markets. “You see it in the 10-year Treasury, touching two (percent yield) today. Markets have already priced in the withdrawal of accommodation, and that is them hearing what the Fed is clearly communicating."

The economy isn't facing a wage-price spiral that could justify a half-point move, and even with four hikes policy would still be accommodative versus the 2.5% neutral rate, Daly said. “I don't see us as behind the curve, I see us as appropriately transitioning policy as the economy demonstrates that it’s clearly able to sustain itself."

FED NEEDS TO ACT

Daly spoke hours after the U.S. reported CPI quickened to 7.5% in January from a year ago following December’s 7.0%, marking the fastest pace since 1982. Energy prices surged 27% and excluding food and energy the CPI gained 6.0%. Economists at BofA and ING say the inflation figures make a 50bp hike more likely and the CME FedWatch Tool is pricing in bets on a half point hike in March.

Inflation is “uncomfortably high,” Daly said. “This is obviously a period of time when, with high inflation and a strong job market, when the Fed needs to act.”

“We know historically that if we adjust too quickly, or too aggressively, that we can actually find ourselves over-bridling the economy; that is really bad for the economy because it throws businesses and households and others into a potential downturn,” she said. “That's why we don't just abruptly and aggressively go all the way up to the neutral rate of interest.”

Inflation will moderate this year as the pandemic eases and consumer spending rebalances from goods to services, and with a slower pace of fiscal stimulus, Daly said. “We had the fiscal, we had monetary, we had the over-rotation of goods and we had broken supply chains. All of those are super pressurizing inflation in 2021. All of those factors are expected to change in 2022,” she said, meaning “data dependence is so critical.”

DANGER OF OVERCORRECTING

That won't be enough to pull inflation down to the Fed's goal this year, she said. “I want to see it get off these high readings and march downward, but it would not surprise me if we ended up in the high twos or three [percent]. I really want to hesitate to give a specific number but I'm going to say it would not surprise me if it's above our target.”

The job market is "really strong" by most measures, but faces challenges from a pandemic that's keeping people closer to home to take care of family, she said. Wage gains aren't like the 1970s because of lower unionization rates and few contracts with cost-of-living adjustments, she said.

“We have to adjust policy so that we're not overheating the economy getting too much inflation and then really needing to make an abrupt shift, so that's why I'm very supportive of an increase in March, barring any negative events of course," she said. "But the other thing is that overcorrecting to a point where we bridle the labor market would end up actually undermining our full employment goal.”

Source: BLS