MNI INTERVIEW: Fed Might Hold Longer Than Market Thinks-Bair

The Federal Reserve could have to keep interest rates higher for longer than investors think, perhaps into next year, because inflation is proving more stubborn than previously thought and as fiscal policy works against the tight monetary stance, former FDIC Chair Sheila Bair told MNI.

“They’re wise to keep the priority on fighting inflation. The data just isn’t there yet to have confidence that this is a sustainable trajectory to 2%,” said Bair, who chaired the FDIC from 2006-2011, speaking in the latest episode of MNI’s FedSpeak Podcast.

Bair said markets keep getting ahead of themselves in pricing in rate cuts because Wall Street wants to goose returns on its financial assets, but that in turn loosens financial conditions in a way that forces the Fed to stay tighter.

“Wall Street is so eager for those rates to go down, they’re creating expectations that they will go down more than they probably will or should,” she said.

FOMC members revised down their expectations for rate cuts this year to a median of just one in their June Summary of Economic Projections, down from three in March. The latest inflation figures, while benign, were not enough to convince policymakers that inflation is reliably on its way back down to the 2% target, said Bair.

“We had a pretty good CPI report but a lot of that was attributable to gas prices, which are volatile, it’s not necessarily a sustainable trend. Housing is still a real problem.” (See MNI INTERVIEW: Good Chance Fed Won't Cut Rates In 2024-Plosser)

FISCAL LARGESSE

No matter who wins the presidency in November, the fiscal boost that helped fuel the 2022 inflation surge and has kept the economy more resilient than expected is likely to persist into next year, Bair said.

“I think fiscal policy’s impact is not evaluated as much as it should be. We are still engaging in massive deficit spending even though the economy is strong,” she said.

“A lot of it is inflationary, it creates more demand for labor, goods, services. That kind of really outsized federal spending has an inflationary impact. And I think that will be true under Trump, it probably will be worse - Democrats want to spend, Republicans want to cut taxes." (See MNI INTERVIEW: Fed's Next Move Could Still Be A Hike-Posen)

She said trade restrictions that are already percolating under the Biden administration would be supercharged under Trump, which would reignite inflationary pressures on the supply chain.

“Fiscal policy will be fighting the Fed and I think it will force the Fed to keep rates a lot higher than probably people would like,” said Bair.

HIGHER RATES WELCOME

That said, Bair thinks higher interest rates are generally not a bad thing after a prolonged period of unusually low borrowing costs that she believes warped economic incentives.

“Rates were abnormally low and distortive for well over 10 years. I think rates need to be higher, permanently. It just creates more discipline around capital allocation. Some of the extreme leverage and consolidation activity that was enabled by ultra-low rates, you get rid of some of that,” Bair said.

“I want them to stay to some extent high, they can come down a little bit. I want higher for longer, I think that’s better for the economy longer run and its productivity.”