MNI: War Makes Fed More Cautious On Tightening –Ex-Officials

Federal Reserve officials are likely to tighten monetary policy more cautiously than previously intended despite high inflation as they assess the hit to growth from surging energy prices in the wake of Russia’s invasion of Ukraine, former top policymakers and staffers told MNI.

“The base case has to be a 25-basis-point move next week,” citing continued economic momentum and upside inflation risk, said Dennis Lockhart, former president of the Federal Reserve Bank of Atlanta.

But the FOMC may shy away from hints at future moves, emphasizing that decisions are being made on a meeting-by-meeting basis, although the dot plot in the Summary of Economic Projections will still offer some clue into officials' expected tightening path.

“I doubt there will be signaling of the next move or a series of moves,” Lockhart said. “The committee can't ignore the ambiguity of the current policy-making circumstances and the uncertainty about how the war evolves. Compared to a few weeks ago, I expect a circumspect and measured tone coming out of this meeting.”

Jeff Fuhrer, a former economist and policy adviser at the Boston Fed, also sees a prospect for greater circumspection due to the uncertainties of war, despite the initial upward hit to inflation with oil prices surging past USD120 a barrel.

TRACKING CONFIDENCE

“They’ll be monitoring confidence in a variety of ways, through financial markets and through less timely indicators. They are no doubt worried that confidence will tank and that they will have to move more slowly,” he said in an interview.

“They may even pause. They might not do anything more than 25 basis points. They might even pause and wait for the first increase until a bit later this spring. Because it's a significant development there’s no doubt about it.”

Before war broke out, markets had been pricing in an increasingly hawkish path for rate hikes, with as many as seven priced in for this year. Data on Thursday is expected to show a 7.8% jump in consumer prices in the year to February, while last week’s employment figures pointed to a booming job market and showed much stronger-than-expected gains.

The advent of the Ukraine conflict, however, with potential financial stresses ranging from commodity price spikes to the prospect of a Russian debt default, raises concerns about the hit to global confidence among consumers, businesses and investors.

“I imagine there is a great deal of communication going on among major central banks,” said Lockhart. “They're looking at dollar funding markets all over the world, they're looking at unknowns related to how Russian banks and payments might rattle markets, and they're assessing financial stability risk.”

(See: MNI STATE OF PLAY: ECB To Opt For Caution As War Fuels Prices)

HIT TO GROWTH

Then there’s the issue of how much the war and its effect on energy costs will slow the recovery’s momentum.

“I’m still of the perspective that to some extent inflation fixes the problem of inflation – it’s going to cut into demand,” said Rick Roberts, a former New York Fed executive now at Monmouth University. “I think the Fed was going to move cautiously anyway, but I think this Russia-Ukraine conflict just gives them cushion to fall back on to explain why they’re moving cautiously.”

That doesn’t mean that interest rates won’t have to move substantially higher to deal with the highest inflation levels in 40 years.

“Financial conditions are volatile and the uncertainty around them and outcomes has increased. So the pace hereafter could well involve game time decisions,” said Richard Berner, former head of Treasury’s Office of Financial Research and now a professor at NYU Stern.

“They’ve got to react to inflation, but the point is they can’t be as aggressive. Because then you’ll risk more economic weakness than you’d otherwise have. Soft landings are hard – there’s a lot of luck involved.”