MNI POLICY: Fed Officials Clash On Extent Of Rate Restraint

Federal Reserve policymakers are actively debating just how much restraint a 23-year high fed funds rate is exerting on the economy, with the FOMC's core leadership arguing policy is constraining the economy enough to bring inflation down to target but a number of officials worried monetary conditions might still be insufficiently restrictive.

One key point of agreement is that inflation is likely to continue to move down while labor markets loosening gradually and economic activity slows. However, officials differ on the degree of confidence they have in such an outcome -- minutes from the May meeting showed "various" members were open to additional tightening should a deterioration in the outlook warrant.

The dovish side of the committee is stressing the need for patience, highlighting the economy's underlying strength as lessening the urgency of any immediate decisions. New York Fed President John Williams said Thursday the central bank has the time to collect more data before making any policy decision.

"At some point interest rates in the U.S. will eventually need to come down, but the timing will be driven by how we're doing on our goals and how do we best balance the various risks," he said. There is "ample evidence" that monetary policy is restrictive, he added.

Chair Jerome Powell earlier this month said the Fed needs to "let restrictive policy do its work," while vice chair Philip Jefferson believes policy is in restrictive territory "as we continue to see the labor market come into better balance, and inflation decline."

Governor Christopher Waller last week said "recent data on the economy indicate that restrictive monetary policy is helping to cool off aggregate demand."

KEEPING OPTIONS OPEN

Other officials, however, have entertained the idea that the Fed's policy rate may not be putting as much downward pressure on the economy and inflation as thought.

Minneapolis Fed President Neel Kashkari has said the plateauing of inflation in the first quarter raises questions about how restrictive policy really is. Dallas President Lorie Logan said there's good reason to believe the neutral rate has risen and policy may not be as restrictive as anticipated. (See: MNI INTERVIEW: Fed’s Next Move Could Still Be A Hike - Posen)

Those uncertainties and the first quarter data showing hot inflationary pressures means the Fed is opposed to locking into any particular path for monetary policy -- and it has become more averse to providing calendar-based guidance on future interest rate cuts.

Fed officials have instead taken to talking about scenarios, focusing attention on broadly different near-term paths the economy might follow, and their likely reaction to each case. It's a sign of just how uncertain officials feel about the outlook. (See MNI: Fed Messaging Swings Boost Policy Volatility -Ex-Officials)

Higher-than-expected inflation data at the beginning of the year pushed back expectations for the Fed's first rate cut. Markets are now pricing in just over one cut near the end of the year, compared to the six projected at the start of 2024. Fed officials in March projections expected three rate cuts this year, but more recently have signaled that another rate increase, while not likely, is not completely off the table. U.S. core PCE rose 2.8% in the year to April, still too far above the 2% target for the Fed's comfort.