MNI INTERVIEW: Fed Might Not Cut Rates In 2024-Andolfatto

The Federal Reserve might not get enough evidence that inflation is coming down to target in order to cut interest rates before the end of the year, and is likely to face a longer-term struggle to contain price growth as deflationary forces which have benefited the U.S. recede, former St. Louis Fed senior policy advisor David Andolfatto told MNI.

Structural forces like ballooning fiscal deficits, driven in part by rising military expenditures, are replacing the transitory factors like gummed up supply chains as primary drivers of upward price pressures, Andolfatto said.

“I personally don’t see any cuts this year,” he said in an interview with MNI’s FedSpeak Podcast. “They need to see inflation remain low, near target, on a sustained basis – and I interpret that being between 2.5 and 2%.”

From a risk-management perspective, the Fed would likely prefer to wait too long to cut rather than easing too soon and allowing price pressures to reignite.

“Their worst case scenario is they hit 2%, they put the foot on the gas or they take the foot off the brake and then suddenly inflation reaccelerates,” said Andolfatto, who left the St. Louis Fed in 2022 and is now chair of the economics department at the University of Miami Patti and Allan Herbert Business School.

While additional interest rate hikes seem unlikely for now, they are not altogether implausible given the possibility that whichever candidate wins a second term presidency is likely to keep the fiscal boosters firing.

“There’s a chance. I don’t think one should rule out the possibility that inflation comes in a little hotter and disappoints. Indeed it might, in some circumstances down the road, spike,” he said.

“One could well imagine the Fed being in a holding pattern throughout the year and then suddenly if these new programs are being announced by a new administration, one could very well see the Fed going in the opposite direction.” (See MNI INTERVIEW: Fed's Next Move Could Still Be A Hike-Posen)

SECULAR FORCES

Andolfatto believes that the aftermath of Covid and the rise of China as a global military superpower are reversing long-run deflationary trends that benefited the United States for several decades.

“What’s different here is that these deficits that are occurring and are being projected, the deflationary force that was in place before seems to have dissipated. It’s not so clear anymore that global demand for the U.S. Treasury will grow as rapidly as it has in the past,” he said.

“I’m very worried about the fact that China has emerged as a legitimate global rival to the United States. What we know from history is that wars are very costly, even cold wars.”

Andolfatto says funding the kind of proxy fights that are likely to accompany this global rivalry will weigh on the budget, fueling inflation.

“In the context of this secular force, the dissipation or evaporation of this deflationary force that we’ve benefited from being replaced with this inflationary force – I think the Fed is going to have a hard time getting inflation back down to 2% and keeping it down.”

JUNE MEETING

As for next week’s meeting Andolfatto expects the Fed’s messaging about the need for patience to remain the same.

“I expect them to continue as a group to caution on any rate cuts. Inflation is still high relative to target,” he said, citing the views expressed by Chris Waller, his former boss in St. Louis and now a highly influential Fed board governor. (See MNI POLICY: Fed Officials Clash On Extent Of Rate Restraint)

“The economy is strong, there are signs of weakening in some sectors but nothing to be too concerned about at this stage. And conditional on the labor market being robust, the Fed really doesn’t have a history of cutting rates in these circumstances, when inflation is above target.”