MNI INTERVIEW-Dovish Powell Lowers ‘Upside Risk’ To Peak Rates

Federal Reserve Chair Jerome Powell’s dovish commentary on inflation last week indicated the FOMC may be returning to a more forecast-based monetary policy, lessening the risk that interest rates will peak much above market expectations around 5%, ex-Fed board economist Jonathan Pingle told MNI.

Powell surprised investors by changing his tune from his recent public pronouncements, including the last two press conferences and his Jackson Hole speech. While he had previously said it was too soon to argue inflation had peaked, Powell offered a more nuanced view of prices in remarks at the Brookings Institution which suggested he believes the high point has passed.

“I was surprised at how forecastey the comments were on Wednesday, reinforced by the fact that Gov. Lisa Cook had spoken just before with kind of a similar shift,” said Pingle, who spent four years at the board and is now chief U.S. economist at UBS.

Powell’s comments “took out some of the upside risks about how high they will go, how much they would think they need to really hammer the economy in order to accomplish what they need to accomplish,” said Pingle.

In particular, Powell highlighted the need to see “core services” inflation outside of housing come down while signaling that he expected a drop in the cost of new rental leases, a key driver of core prices that affects CPI with a long lag. (See MNI INTERVIEW-U.S. Inflation Likely At Turning Point--SF Fed)

“I get a fair amount of questions about what if rates are going to 6%? St. Louis Fed President James Bullard had laid out policy rules where he had one option that went to 7,” Pingle said. “What we heard from Powell was not someone who feels like rates need to be marched up to 6.25%.”

FORECAST-BASED POLICY

Indeed, a return to forecast-based policy would indicate a significant shift in thinking at the central bank as interest rates rise to levels policymakers consider restrictive. Officials until recently emphasized the need to see actual declines in headline inflation rather than focusing on forecasts, previously proven premature, that inflation was set to fall.

FOMC members have said they will likely ease the pace of rate increases from a recent string of outsized 75-basis-point hikes to 50 basis points in December, in part so they can take stock of the cumulative and lagged effects of tightening to date.

“It seemed to me something of a shift from the backward looking, we need to see it in the inflation data to believe and back toward forecast-based monetary policy,” Pingle said. “That matters for how we want to think about policy next year. If they’re going to go back to putting more weight on where they think inflation is headed then they might react a little less to where inflation is now.”

Pingle thinks market expectations for rates to peak around 5% are likely correct given the recent path of the data and official pronouncements from the Fed.

"We’re expecting them to do 50 in December then we expect another 50 bps in February. If you told me they were going to do another 25 after that I don’t have a strong conviction one way or the other," he said.

“My basic premise is that they have in mind a terminal rate of 5%, plus or minus. They’re going to want to fulfill that to some extent even if inflation slows, because they’re probably going to interpret what’s unfolding as what they priced into their forward communications but they’ll be reluctant to fall too far short of that."