MNI INTERVIEW: Disinflation Stall Could Push Fed To 6% Or More

Stubborn U.S. inflation pressures could force the Federal Reserve to consider raising interest rates to 6% or more by early next year, former New York Fed economist Matthew Raskin told MNI.

While a continued improvement in the inflation outlook and softer growth could allow the Fed to keep rates at a 22-year high of 5.25%-5.5%, there is also a decent possibility that resilient economic activity and price pressures will force a resumption of hikes after a multi-month pause.

“It will depend importantly on whether the rise in long-term interest rates that we’ve seen over recent months and the tightening of broader financial conditions persist,” said Raskin, a former senior policy adviser who spent 15 years in the Fed system, told MNI's FedSpeak Podcast. “The chances are good that they’re done, but I do put decent odds on further hikes. The conversation will probably center on whether they’ve got 50 basis points or more to go. It probably opens up 6% as the next logical terminal rate for the cycle.”

The current debate around whether the Fed will hike further is too focused on the idea of just one additional quarter point increase, Raskin said.

“That’s understandably informed by the SEP dot plot. But that seems too narrow to me,” he said. “If the committee pauses next week as I expect, and the data unfold in a way that makes it look like they’ve got more tightening to do in December or later, I think it’s unlikely that it’s just 25 basis points.”

YIELD SURGE

Raskin, now head of U.S. rates strategy at Deustche Bank, said understanding the underlying reasons for the surge in 10-year note yields to their highest since 2007 as well as spikes in other forward rate measures was important to determining the future course of Fed action.

“To the extent that those increases reflect an exogenous rise in the term premia, that may call for less Fed policy hiking that would otherwise be necessary,” he said.

“If, though, the moves in the long end have been driven by improving economic prospects and a corresponding shift up in views of long run neutral, that might actually call for more rate hikes just to preserve the same degree of policy restraint relative to that higher level of neutral interest rates.”

HIGHER R-STAR

Raskin said there’s good reason to believe the neutral rate of interest has probably risen, not just in the short-run but also over a longer horizon.

“The neutral level of short-term rates is higher than we’d come to believe. Certainly short-run r-star is higher but I also think long-run r-star is,” he said. “That would make sense just given the resilience of the data while the Fed has hiked more than 5 percentage points.” (See MNI INTERVIEW: Richmond Fed’s R-Start Estimate Rises To 2.3%)

The Fed can try to use the idea of "higher for longer" as forward guidance but it might not be enough to deal with a resurgence of inflation.

“That’s a challenging dimension for the Fed to operate on, especially if we get upside inflation shocks. That could be tricky and I think that’s a scenario where you probably have to respond with action rather than just saying now we’re going to hold at this high level for longer than we previously thought,” Raskin said.

He said the economy has remained unusually insulated so far to the Fed’s 525 basis points of tightening, but that was in part due to lagged effects of policy, amplified by things like the prevalence of fixed rate mortgages and loans.

“It takes time for policy tightening to work through the system. I do think over time the tightening the Fed has done is going to gain further traction on the real economy,” Raskin said. (See MNI POLICY: Fed Convinced Past HIkes' Full Effect Still To Hit)