– Allows For Sooner or Faster Rate Cuts If Needed, But Not Her Base Case
By Steven K. Beckner
(MaceNews) – Cleveland Federal Reserve Bank President Loretta Mester warned Tuesday that the Fed could lose its gains against inflation if it were to start cutting interest rates too soon.
Advocating a “cautious” and “gradual” approach, she said she does not envision rate cuts until “later this year.“
Mester, a voting member of the Fed’s rate-setting Federal Open Market Committee, did not rule out earlier or faster cuts in the federal funds rate, but made clear that is not her “base case.”
“Monetary policy is in a good place from which to assess and respond to these risks to the outlook,” she said in remarks prepared for delivery to the Ohio Bankers League Economic Summit in Columbus, Ohio. “The current strength in labor market conditions and the strong spending data give us the opportunity to keep the nominal funds rate at its current level while we gather more evidence that inflation truly is on a sustainable and timely path back to 2%.”
“This is better than finding ourselves in a situation where we begin easing too soon, undo some of the progress we have made on inflation, potentially destabilize inflation expectations, and then have to reverse course,” Mester continued.
“If the economy evolves as expected, I think we will gain that confidence later this year, and then we can begin moving rates down,” she went on. “My base case is that we will do so at a gradual pace so that we can continue to manage the risks to both sides of our mandate.”
Mester, who will be retiring from the helm of the Cleveland Fed at mid-year, added, “Of course, if downside risks materialize, we would have the opportunity to move rates down more quickly….”
Mester has a reputation as one of the Fed’s biggest inflation “hawks,” but her comments did not differ markedly from what other Fed officials have been saying lately.
Her remarks came less than a week after the FOMC kept the federal funds rate target unchanged in a 5.25% to 5.50% target range, but dropped a long-standing tightening bias in favor of more neutral policy guidance in preparation for eventual rate cuts.
Chair Jerome Powell told reporters after the meeting that the funds rate is “likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year.”
However, Powell disappointed many on Wall Street by explicitly downplaying chances of a March 20 rate cut and by stressing that “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”
“The economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2% inflation objective is not assured…,” he said, adding that the FOMC is “prepared to maintain the current target range for the federal funds rate for longer, if appropriate.”
Subsequently, a stronger than expected January employment report, which included a surprising upsurge in wages, further dampened early rate cut talk.
Mester did not diverge significantly from Powell’s message. She provided little encouragement to those hoping for early or aggressive rate cutting.
Like Powell, she said the economy is “in a good place,” but said, “The FOMC’s job now is to ensure that the economy reaches an even better place by calibrating monetary policy to achieve our dual mandate goals of price stability and maximum employment.”
After noting last year’s moderation of inflation, she warned, “There are reasons to be cautious in assuming that last year’s rapid pace of disinflation will be maintained as inflation gets closer to the 2% goal.”
“While restrictive monetary policy has played an important role in moving inflation down, supply-side adjustments were also important,” she said. “Now that pressures on supply chains are approaching normal and the labor market is coming into better balance, we should not count on as much help from the supply side as we saw last year….”
Echoing last Wednesday’s policy statement, Mester said, “The FOMC does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%….”
“It would be a mistake to move rates down too soon or too quickly without sufficient evidence that inflation was on a sustainable and timely path back to 2%,” she warned. “Doing so would undermine all of the good work that has gone into getting inflation to this point.”
Mester did add a caveat on the other side, however: “On the other hand, if year-ahead inflation expectations continue to decline, maintaining the current level of the nominal fed funds rate for too long would effectively be a tightening in our policy stance, which would pose an increasing risk to the maximum employment part of our mandate ….”
Risk management will be the FOMC’s modus operandi going forward, she said.
Echoing Powell’s statement that economic risks have become more balanced, Mester said, “Our job is to calibrate monetary policy to the evolving outlook and risks around the outlook so that inflation returns sustainably to our 2% goal and labor markets remain healthy.”
But she erred on the side of concern about a possible resurgence of inflation. “My baseline forecast is that output and employment will moderate this year and inflation will continue to move closer to our 2 percent goal over time. But there are a number of risks around this forecast ….”
In particular, she warned, “a continued easing in financial conditions could spur activity, leading once again to imbalances that fuel inflation …..”
While some of her colleagues have warned against real rates becoming too restrictive as inflation falls, Mester took a contrary view. “(T)he strong output and employment growth could be an indication that the neutral rate of interest, which rose during the pandemic, might remain high, which would mean restrictive policy may be needed for longer to achieve our goals of price stability and maximum employment ….”
Other Fed officials who have spoken since the FOMC met have also taken a cautious, gradualistic approach to rate cuts, seemingly delaying the start of easing and limiting its extent.
Last Friday, Governor Michelle Bowman said, “it will eventually become appropriate to gradually lower our policy rate to prevent monetary policy from becoming overly restrictive” if “incoming data continue to indicate that inflation is moving sustainably toward our 2% goal,” but she said, “we are not yet at that point.”
Bowman said the Fed may yet have to raise rates further. “While the current stance of monetary policy appears to be sufficiently restrictive to bring inflation down to 2% over time, I remain willing to raise the federal funds rate at a future meeting should the incoming data indicate that progress on inflation has stalled or reversed….”
Bowman said, “a number of important upside inflation risks remain.” Among them, she cited “the risk that continued easing in financial conditions could add momentum to demand, stalling any further progress in lowering inflation, or even causing inflation to reaccelerate.” She also saw “a risk that continued labor market tightness could lead to persistently high core services inflation….”
She warned “reducing our policy rate too soon could result in requiring further future policy rate increases to return inflation to 2 percent in the longer run.”
Chicago Fed President Austan Goolsbee has a more “dovish” reputation, but he went on PBS Friday evening to say he wants to see more disinflation. “I think more and more progress like what we have seen on inflation and on jobs is what we need to see to feel comfort that we’re on target….(S)o far, it’s been going pretty well….(W)e just want to make sure that we’re on path to see that.”
Powell himself reiterated a ”careful,” data-dependent approach to rate cuts in a Sunday night appearance on CBS’s 60 Minutes program.
“The prudent thing to do is…to just give it some time and see that the data confirm that inflation is moving down to 2% in a sustainable way,” he said. “We want to approach that question carefully,”
Powell refrained from saying the U.S. is making a “soft landing,” but said, “We think the economy’s in a good place. We think inflation is coming down. We just want to gain a little more confidence that it’s coming down in a sustainable way toward our 2% goal.”
Minneapolis Fed President Neel Kashkari disputed contentions that the funds rate is getting too tight in real terms as inflation declines in an essay released by the Bank Monday. And so, he argued, the FOMC can take its time easing policy.
After pointing to relatively high home prices and stock values and to strength of durable goods spending and other economic aspects, he wrote, “This constellation of data suggests to me that the current stance of monetary policy, which, again, includes the current level and expected paths of the federal funds rate and balance sheet, may not be as tight as we would have assumed given the low neutral rate environment that existed before the pandemic.”
“It is possible, at least during the post-pandemic recovery period, that the policy stance that represents neutral has increased,” he continued. “The implication of this is that, I believe, it gives the FOMC time to assess upcoming economic data before starting to lower the federal funds rate, with less risk that too-tight policy is going to derail the economic recovery.”
FOMC participants projected three 25 basis point rate cuts in December – only about half of what financial markets had priced in. The FOMC will be collecting a new set of rate “dots” at its March meeting.
In other comments, Mester echoed Powell in saying the FOMC will begin earnest discussions of its balance sheet strategy in March.
She noted that “so far, the balance-sheet runoff has resulted in a reduction in (overnight reverse repurchase agreements), with balances currently under $575 billion, rather than a reduction in reserves” to about $3.5 trillion.
Citing the Fed’s September Senior Financial Officer Survey, she said “for most banks, their reserve levels are above their preferred level of reserves, and money market rates and spreads suggest little in the way of funding pressures. And the Fed’s Standing Repo Facility provides a backstop against such pressures.”
“So the current level and distribution of reserves are more than ample,” she added.
“But as balance-sheet runoff continues and ON RRP volume reaches a minimum level, reserves will begin declining, too, and more redistribution of reserves will need to occur across institutions,” Mester said. “As our balance-sheet reduction plan noted, the FOMC will slow and then stop the runoff when reserve balances are somewhat above the level it judges is consistent with ample.”