Financial conditions are tightening, helping to moderate inflation expectations, the research director of the Minneapolis Fed tells MNI.
U.S. businesses and consumers are still confident inflation will come down over a longer horizon despite the recent surge in prices across the economy, in part because they are already feeling the pinch of tighter financial conditions arising from Fed rate hikes, Minneapolis Fed Research Director Mark Wright told MNI.
Business investment decisions tend to be made over a seven- to ten-year period, while households looking to get a mortgage opt most commonly for a 30-year loan, he said in an interview. In both cases, rates have moved sharply higher not just because of the Fed's monetary tightening to date but also expectations of further rate increases.
“The fed funds rate or overnight rate can have a negative real interest rate, but the interest rates people care about which are over seven, ten, thirty years, those real interest rates can be positive and those are the ones that we’re paying a lot of attention to," Wright said in an interview. (See also MNI INTERVIEW: Fed Should Slow Hikes As Neutral Nears-Wright)
"Financial conditions as a whole have tightened very significantly. Thirty-year mortgage interest rates are about 5-¼% now and it’s not so long ago that they were under 3%," he said.
NO WAGE-PRICE SPIRAL
At the same time, he said, fears of a wage-price spiral have thus far not been born out.
"We’re only seeing wage increases picking up in a relatively small number of occupations in a small number of places. A lot of the deals we’re seeing being negotiated through unions make some kind of adjustment but they’re not locking in lots of wage increases in the future,” he said.
“I think that’s because they’re very concerned that if they do that will lead to negative employment effects once the inflation rate comes down. I take that as being consistent with the belief that inflation will stabilize, so that’s comforting.”
However, Wright added this was no reason for complacency in the face of high inflation that has far surpassed official expectations.
“The Federal Reserve Act doesn’t give us a mulligan if it’s caused by supply issues – we’re supposed to get stable prices regardless of where it’s coming from,” he said, “If we don’t get inflation down real soon there's a very real risk that people will begin to think it’s entrenched and start acting accordingly."
CAN’T IGNORE RECESSION RISKS
Wright said the Fed is mindful of recession risks as it tightens monetary policy and as overseas economies slow, with Europe facing a hit from the war in Ukraine and its effect on energy prices while China copes with Covid lockdowns.
“We have a mandate to pursue both stable prices and maximum employment, so we can’t ignore concerns that we might induce a recession,” Wright said.
“We’re well aware of the danger, and we’d certainly rather avoid a recession, but I think we’re prepared for a little bit of risk of that if it helps us get our stable prices objective back under control,” he said. “I don’t think we’re in incipient territory by any means but it’s something we’ll be paying very close attention to.”
Wright said job market conditions could sour if economic conditions deteriorate, despite the labor market tightness that has characterized the rebound from the Covid recession and a historically low jobless rate of 3.6%.
“It’s possible that could begin to change quite quickly. We’re starting to see some major corporations saying that they’ll be looking to reduce their staffing levels, particularly in retail,” he said. “We could start to see that show up in the data soon, hopefully it shows up in a steady not dramatic way.”