Rpt- MNI INTERVIEW-Fed Could Pause Hikes As Early As Mar –Sahm

The Federal Reserve is likely to further reduce its rate hike pace to a quarter point at its Feb. 1 decision and could be on track to pause rate increases altogether after that as inflation shows further signs of softening, former Fed board economist Claudia Sahm told MNI.

Sahm said the strength of the labor market means the Fed can still pull off a soft landing, but only if it backs off of the idea that it must significantly weaken employment conditions in order to reduce price pressures.

“I think there’s a path towards a 25 basis point increase at the coming meeting. And if the good news keeps coming in, they could pause,” she said in an interview with MNI’s FedSpeak podcast.

“In the press conference, Jay Powell laid the groundwork, he didn’t promise 25 but it did come out of his mouth and we’ve seen again Mary Daly recently. And Lael Brainard for months has been a voice saying ‘we shouldn’t go too fast.’”

HOUSING TO BECOME CPI DRAG

Sahm, also previously a senior economist at the White House Council of Economic Advisors, said signs of easing inflation pressures are coming not only from the unsnarling of supply chains and weak imports prices but also from a decline in rental costs that she says will soon be reflected in the CPI. (See MNI INTERVIEW: CPI Could Bring Forward Fed Pause-Ex-Staffer)

“On the market, rent prices are falling. We’re going to have housing services be a drag on inflation. By June, late spring, early summer, those prices could fall,” she said. “And housing services is a good bit of CPI. And we’re going to see other things turning over. Supply chains are healing, import prices look good. There’s a whole bunch of things that are looking good.”

Tomorrow’s CPI report is hard to predict but she said it the consensus about a better-than-expected reading could prove misguided.

“Yes, we’re seeing improvements but this is going to be a wild ride,” she said.

NO RATE CUTS THIS YEAR

Sahm said the prospect that growth will hold up nicely this year will mean that the Fed will follow through on its promise, thus far not believed by markets, not to cut interest rates in 2023.

“I take them at their word. I think the Fed is very serious about saying they’re not going to cut even when unemployment goes up,” she said. “They think 4% unemployment is sustainable for the economy, we’re at 3.5%. The Fed would be happy, or comforted if we get another half a percentage point on unemployment.”

Still, she said the idea of raising unemployment just enough to cool off inflation pressures is “playing with fire,” particularly in light of her research, codified in something known as the Sahm rule, which suggests joblessness can take on self-fulfilling momentum.

“That’s what my recession indicator shows – you get a half a percentage point increase relative to the low of the prior year and you’re in the early months of a recession,” she said.

“It could break this time, meaning you get a half a percentage point and you go up a little bit more but it stops. But not only has it happened historically, but there’s a logic to, once unemployment gets going it keeps going. You start getting these feedback effects.”