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MNI INTERVIEW: Fed Might Need Bigger Cuts If It Waits Too Long

Federal Reserve

The U.S. economy could weaken more than expected if Federal Reserve officials wait too long to cut interest rates, potentially forcing policymakers to kickstart their easing cycle with a 50-basis-point rate cut, former senior Treasury official Tara Sinclair told MNI.

Sinclair is more concerned about an unexpected labor market weakening, particularly considering the gradual but substantial rise in the jobless rate over the past year to 4.1%, than about some kind of inflation resurgence.

“The thing that worries me is we could get rough enough data that they actually have to kickstart it into a 50-basis-point cut,” said Sinclair, who stepped down last month from her role as Deputy Assistant Secretary for Macroeconomics in the Office of Economic Policy at the Department of Treasury

She thinks the Fed is likely to wait until September to begin cutting rates because officials were spooked by hints of stronger price pressures in the first quarter of the year. Sinclair believes seasonal factors contributed to the higher readings for inflation, which has since resumed its decline.

“I would be pushing for starting cutting. I would do an initial 25-basis-point cut at the end of July,” said Sinclair, also a former visiting scholar at the St. Louis Fed.

ROOM FOR MANEUVER

She thinks the FOMC has needlessly trapped itself into the idea that the first rate cut is some kind of sacrosanct, immutable policy change.

“They've kind of painted themselves into a little bit of a corner by saying that the worst thing in the world would be if they cut and then had to turn back around and raise again. I don't see why that's the worst thing in the world.”

By keeping rates at a 23-year high of 5.25-5.5% even as inflation falls, the Fed is effectively tightening policy and putting additional strain on demand, Sinclair said. (See MNI INTERVIEW: Fed Already Well Behind The Curve On Cuts -Tracy)

“This whole focus on the first cut – to me it’s just 25 basis points, it shouldn’t be as consequential as it seems like it’s going to be,” she said.

GOLDILOCKS, FOR NOW

While the labor market is still healthy, Sinclair believes the jobless rate is already above the level, known as the non-accelerating inflation rate of unemployment or NAIRU, that can be sustained without generating inflation.

She also noted labor market conditions can change very quickly, especially if consumption falters – and there are mounting signs that growth is already easing.

“It’s Goldilocks but we don’t know the end of the story yet. You can be passing through good times and then have more stable good times ahead, or we could see further weakening,” said Sinclair, now back in her role as director of The George Washington University’s Center For Economic Research. (See MNI INTERVIEW: Rising Risk Of Sharper US Factory Slowdown-ISM)

“That’s why every economist I talk with that’s tracking this data closely is biting their nails to see, is this soft landing going to stick or are we going to continue to see more declines in the real economy that we’ve gotten used to hoping for?”

DRY POWDER

Sinclair said the neutral interest rate has likely risen post pandemic and that that’s a good thing, in part because it will help the central bank avoid the problem of the zero lower bound on interest rates faced after the Global Financial Crisis.

“I’m optimistic that R-star is a little bit higher. There's a lot of reasons, from my perspective, to be optimistic about higher interest rates for longer. It probably means the Fed isn't immediately turning around and fighting a deeper downturn than they're anticipating,” she said.

“That's great from the perspective of the real economy. That's great from the perspective of keeping some keeping the powder dry for the Fed, for the future.”

MNI Washington Bureau | +1 202 371 2121 | pedro.dacosta@marketnews.com
MNI Washington Bureau | +1 202 371 2121 | pedro.dacosta@marketnews.com

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