By Steven K. Beckner
(MaceNews) – Federal Reserve policymakers expressed a determination Wednesday to keep raising interest rates to combat inflation – possibly higher than previously projected.
New York Federal Reserve Bank President John Williams said that, for now, a 25 basis point pace of rate hikes is appropriate, and he said rate cuts could be in play next year if inflation comes down as expected. But meanwhile the Fed might have to increase the pace of rate hikes back to 50 basis points if high inflation persists, said the vice chairman of the Fed’s rate-setting Federal Open Market Committee.
Fed Governor Christopher Waller said the Fed has “farther to go” in raising the federal funds rate and said rates will likely need to stay “higher for longer than some are currently expecting.” He was not specific about how how.
Minneapolis Fed President Neel Kashkari, an erstwhile “dove” who is now on record as projecting a 5.4% funds rate, said most of his colleagues think the policy rate will need to go above 5% to some extent. And the FOMC voter said the Fed will probably need to hold it at that level for “a long period of time.”
The comments came after the FOMC raised the federal funds rate for an eighth time last Wednesday, but at a slower pace. After raising the funds rate by 75 basis points at four consecutive meeting, the FOMC ap[proved a 50 basis point hike on Dec. 14, and decelerated further to 25 basis points on Feb. 1.
The latest move left the policy rate in a target range of 4.50% to 4.75% — 50 basis points shy of the peak rate projected by FOMC participants in February. The FOMC reiterated it expects “ongoing increases” will be appropriate to make the funds rate “sufficiently restrictive” with “the extent of future increases” depending on the Fed’s assessment of “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
Citing the December projections, Chairman Jerome Powell spoke last Wednesday of “a couple” more rate hikes being needed, but he did not rule out going higher. Noting that the FOMC will update rate projections at the March 21-22 meeting, he said, “If we come to the view that we need to … move rates up beyond what we said in December we would certainly do that. At the same time, if the data come in in the other direction then we’ll make data-dependent decisions at coming meetings, of course.”
The Fed chief’s comments were mixed overall, with some hearing a dovish message, while others took more hawkish signals. On one hand, Powell welcomed “disinflation” in goods and housing prices and expressed hope that trend will continue. On the other hand, he said disinflation is not evident in a large part of the economy, namely core service prices excluding housing.
“While recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path,” Powell told reporters. He linked still “elevated” inflation in core services ex-housing to an “extremely tight” labor market where worker shortages are keeping upward pressure on wages.
As if to confirm Powell’s point, two days later the Labor Department announced much larger than expected January payroll gains and a drop in the unemployment rate to 3.4% — lowest since 1969. Average hourly earnings rose at a 4.4% year-over-year pace – down from 4.8% in December, but still faster than the Fed deems consistent with reducing inflation to 2%.
Economic crosscurrents were reflected in two January surveys by the Institute for Supply Management — one showing contraction in manufacturing, the other showing robust non-manufacturing activity.
Would the FOMC have raised the funds rate by 50 basis points had it known how strong the January employment report would be? Powell didn’t let on when asked that question Tuesday, but said the jobs jump “kind of shows you why we think this (disinflation) process will take a considerable period of time…It underscores the message that we have a significant road ahead to get inflation down to 2%…”
Making policy “sufficiently restrictive” will take more rate increases…,” he told the Economic Club of Washington. “Then we’ll look around to see if we’ve done enough.”
Powell was pleased that financial markets and monetary policy became “more aligned” after the employment report.
Williams said Wednesday that “if financial conditions loosen a lot that would be a factor that would have to affect our thinking…That might imply a higher interest rate to ensure ”a “sufficiently restrictive” stance of policy.
Financial markets have been projecting rate cuts later this year, but Williams cast doubt on such expectations, instead looking toward next year at the earliest and tying rate cuts to success in inflation reduction: “If you look at our expectations for inflation coming down this year and coming down further next year..if you think about 2024, if we don’t cut rates at some point, real rates adjusted for inflation will continue to go up…”
But Williams said that for the time being, “we need to make sure interest rates stay in a sufficiently restrictive stance.”
“If inflation comes back to 2%,,,(and) the economy is growing at potential…we will need to get rates back to more normal levels,” Williams said. But to get inflation down to 2%…we will need a sufficiently restrictive stance…”
“We will need to maintain that for a few years…,” he added.
Williams endorsed the deceleration of rate hikes that began in December, but said the FOMC could conceivably need to re-accelerate rate hikes. “Obviously if the situation changes..we would have the ability to move quicker…(but) right now 25 basis points …seems like the right size to adjust policy.”
Estimating the underlying rate of inflation at 3 to 3 ¼%, and noting that the funds rate is about 1% above that, he said that to make monetary policy “sufficiently restrictive…we need to get higher than that..to get sufficiently restrictive to bring inflation down.”
“If the outlook changes, if the outlook for inflation was higher, we would need to have a higher interest rate to make sure we get a sufficiently restrictive stance,” Williams added.
A key input to Fed thinking about the appropriately restrictive rate level is labor demand and wage pressures, he made clear: “We still see strong demand for labor.,. We see that in wage growth; it is well above levels consistent with 2% inflation.”
Kashkari said Tuesday that if he was writing down funds rate projections now, he would be putting down a 5.4% rate for the end of 2023. He did not disavow those comments in Wednesday remarks to the Boston Economic Club, “I’m on the hawkish end of things,” he said. “It seems like the underlying inflation and the ,job market are quite robust right now.”
Although goods prices have moderated, Kashari said, “the service side of the economy is still hot. If you strip out housing, core services ex-housing, we haven’t seen any movement there.”
“There are some hopeful signs, but there’s not much evidence that rate hikes thus far have had much effect on the labor market,” he continued. “We need to do more; how much more I’m not sure yet.’
Referring to the “big surprise” January jobs report, Kashkari also expressed concern about wage pressures. “Right now wage growth is between 4% and 5%; right now wage growth is too high to support 2% inflation.”
Kashkari said “most” Fed officials think the funds rate will need to go above 5%.
“Could it go higher than that?” he asked. “That’s certainly possible. Then the expectation at some point is that we’ll hold rates for period of time — probably a long period of time,” he went on. “Then do we need to go higher from there? Or lower from there? It depends on how fast inflation falls back to the 2% target.”
Waller noted that wages and prices have moderated, but nearly enough for his taste.
“These improvements are welcome news, but we need to keep them in perspective,…,” he told the Arkansas State University Agribusiness Conference. “(T)hough PCE inflation is down from its peak, it is still quite elevated. And while the recent trend is encouraging, the improvements over the past year have been coming in ebbs and flows and it likely will continue this way.”
“I need to be confident that inflation is declining in a sustained manner towards our 2% target, so I will need to see continued moderation in inflation before my outlook changes,” he continued.
Waller did not say how high he thinks the funds rate will need to go or how long it will need to stay there, but his basic view did not diverge from those of Kashkari and others.
The Fed’s effort to curb inflation is “begin(ning) to pay off, but we have farther to go,” he said. “And, it might be a long fight, with interest rates higher for longer than some are currently expecting.”
“But I will not hesitate to do what is needed to get my job done,” Waller added.
Other Fed officials have explicitly said the funds rate will need to go above the December 5.1% median projection.
San Francisco Fed President Daly, the first official to speak after the FOMC meeting Friday, called 5.1% a “good indicator” of where the funds rate is headed, but said she is “prepared to do more than that, if more is needed.”
“We really will have to be in a restrictive stance of policy until we truly understand and believe that inflation will come squarely back down to our 2% target….,” said Daly, who is not usually thought of as a hawk. “I think it’s far too early to declare victory and even think about peaking….”