– ‘Increasingly Concerned About Upside Risks to Inflation’
– Risks of Cutting Too Soon Outweigh Risks of Waiting Too Long to Cut
– Monetary Policy Not as Restrictive As Some Think
– Appropriate Soon to Slow Balance Sheet Run-off
By Steven K. Beckner
DURHAM, N.C. (MaceNews) – Dallas Federal Reserve Bank President Lorie Logan asserted Friday that it’s “much too soon to think about cutting interest rates.”
Logan, speaking at a Duke University Economics Department event, said she’s “increasingly concerned about upside risks to inflation,” and said the Fed’s rate-setting Federal Open Market Committee must be ready to “respond” if inflation stops falling. She said the risks of cutting rates too soon are greater than the risks of waiting too long to cut.
Besides, she contended, monetary policy is not as “restrictive” as some make it out to be, based on rising estimates of the real equilibrium short-term interest rate (r*) and in turn the “neutral” rate.
Logan, who is not voting on the FOMC this year, said it will “soon be appropriate” to slow run-off of maturing securities from the Fed’s balance sheet – that is to moderate so-called “quantitative tightening.”
Before she spoke, the Labor Department reported that non-farm payrolls rose a greater than expected 303,000 in March, while the unemployment rate fell from 3.9% to 3.8%. Average hourly earnings grew 0.3%, a tenth faster than in February, and were up 4.1% from a year earlier. Logan made no comment on those data.
Logan was more concerned about the Commerce Department previous report that the Fed’s preferred inflation gauge, the price index for personal consumption expenditures (PCE), continued to exceed the Fed’s 2% target in February, rising 0.3% and 2.5% from a year earlier. The core PCE rose 0.3% and 2.8% year-over-year. Over the first two months of the year, core PCE inflation has averaged more than 3 ½% at an annual rate.
To support easing monetary policy, Logan said she needs to be “confident in my outlook that inflation is headed to 2%,” but the January and February inflation data “didn’t increase my confidence.”
Logan said she thinks “a benign path to 2% is still a possible path,” but said she needs to be convinced of that.
“We have made substantial progress toward that (2%) objective ..,” she said, but “in the first two months of 2024, however, inflation data surprised to the upside …. (W)hile the benign path back to price stability remains possible, I see meaningful risks to continued progress.”
What’s more, Logan said she is “increasingly concerned about upside risk to the inflation outlook.”
“To be clear, the key risk is not that inflation might rise—though monetary policymakers must always remain on guard against that outcome—but rather that inflation will stall out and fail to follow the forecast path all the way back to 2 percent in a timely way,” she continued.
Given her level of anxiety about wage-price pressures, Logan said, “I believe it’s much too soon to think about cutting interest rates. I will need to see more of the uncertainty resolved about which economic path we’re on. And, as always, the FOMC should remain prepared to respond appropriately if inflation stops falling.”
Elaborating in response to questions, Logan declared, ‘there’s no urgency right now. We have time to wait.”
She added that the Fed is “in a flexible position,” given the strength of the economy and labor markets.
While saying the FOMC should not wait until inflation gets all the way down to 2% to start cutting rates, she said that, for now, “the risks of cutting rates too soon are higher than going too late.”
Powell and others have repeatedly called the Fed’s 5.25% to 5.50% federal funds rate target “restrictive,” but Logan took some exception to that.
“Beyond the inflation data, I’m concerned that the stance of monetary policy may not be as restrictive as most forecasts assume …,” she said, questioning whether financial conditions are “sufficiently restrictive.”
“Failing to recognize a sustained move up in the neutral rate could lead to over accommodative monetary policy,” she warned.
More than many of her colleagues, Logan focused attention on the so-called “neutral” rate – the setting of the federal funds rate deemed to be consistent with price stability and full employment. At its March meeting, FOMC participants belatedly raised their estimate of the “longer run” neutral rate from 2.5% to 2.6%, which implies a 0.6% real rate plus the 2% inflation target.
Logan implied that the neutral rate may actually be considerably higher than that.
She noted that “the right tail of the distribution (of Fed projections) has spread out considerably. Seven FOMC participants now project a long-run fed funds rate of at least 3%—corresponding to a neutral real rate of at least 1 percent—compared with just three participants making such projections a year ago.”
“And economic and financial evidence is accumulating that the long-run neutral rate has likely moved up…,” she continued, noting that among economists who model the neutral rate “none of them gives a point estimate as low as the 0.6 percent median in the latest SEP. “
“Some models estimate a neutral real rate above 2%, corresponding to a neutral federal funds rate above 4 percent given the FOMC’s 2% inflation target,” she added.
Logan also observed that financial market prices seem to reflect expectations of a higher natural rate.
Emphasizing the importance of the neutral rate, she said, “as I formulate my views on appropriate policy, I’m taking evidence of sustained shifts in the neutral rate into account, alongside all the other evidence on the economic and financial outlook. Although the neutral rate is uncertain, using the information we do have on it can help ensure monetary policy is set so that broad financial conditions will be sufficiently restrictive to achieve our dual-mandate goals.”
Before becoming Dallas Fed President in August 2022, Logan ran the New York Fed’s open market trading desk and is considered the FOMC’s leading expert on the Fed’s securities portfolio and balance sheet strategy. She devoted some of her remarks to coming changes in balance sheet policy.
The Fed has been shrinking its balance sheet by $95 billion per month, and she noted that “so far, more than the entire reduction in our balance sheet has come out of the overnight reverse repurchase (ON RRP) agreement facility…As a result, bank reserves have actually increased since 2022.,”
“But ON RRP balances are now down to somewhat above $400 billion,” she continued. “Once those balances are depleted, asset runoff will reduce bank reserves one for one, all else equal. Moreover, the current pace of asset runoff is about twice what it was in early 2019, the last time we normalized our balance sheet.“
“Overly rapid reductions in bank reserves could outpace money markets’ ability to redistribute reserves to the banks that need them most,” she warned. “That would risk pressures that could force us to stop balance sheet normalization prematurely….”
“So, I believe it will soon be appropriate for the FOMC to decide when to slow—not stop—the runoff of our asset holdings,” she went on. “A slower but still meaningful pace will provide more time for banks and money market participants to redistribute liquidity and for the FOMC to assess liquidity conditions. It will also reduce the risk of going too far. I see this as a technical decision to ensure effective policy implementation and support a smooth path to an efficient balance sheet size. It should not have much effect on broader financial conditions….”
Logan is thought of as one of the more “hawkish” members of the FOMC, but many of her colleagues have also sounded the theme lately that there is no rush to cut rates, especially given the strength of the economy and labor markets.
On Wednesday, Chair Jerome Powell stayed on message, repeating “it is too soon to say whether the recent (inflation) readings represent more than just a bump. We do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down toward 2%.”
“Given the strength of the economy and progress on inflation so far, we have time to let the incoming data guide our decisions on policy….,” the Fed chief said.
“I continue to believe that the policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as we expect, most FOMC participants see it as likely to be appropriate to begin lowering the policy rate at some point this year….,” Powell reiterated.
Powell warned, “Reducing rates too soon or too much could result in a reversal of the progress we have seen on inflation and ultimately require even tighter policy to get inflation back to 2 percent. But easing policy too late or too little could unduly weaken economic activity and employment.”
Two voting Federal Reserve Bank presidents took much the same approach. San Francisco Fed President Mary Daly said the three 25 basis point rate cuts projected in the FOMC’s March Summary of Economic Projections are still “a very reasonable base line,” while Cleveland Fed President Loretta Mester said she would “not want to rule that out.”
But neither spoke with any urgency about easing policy.
“Inflation is coming down, but it’s slow. Bumpy and slow,” said Daly. ““There is really no urgency to adjust the rate. Standing pat is the right policy at the moment.”
Mester said “the most likely scenario is that inflation will continue on its downward trajectory to 2% over time. But I need to see more data to raise my confidence….”
“If the economy evolves as expected, then in my view it will be appropriate for the FOMC to begin reducing the fed funds rate later this year, as inflation continues on its downward path toward 2%, and labor markets and economic growth remain solid….,” she continued.
“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,” Mester went on. “On the other hand, moving rates down too soon or too quickly without sufficient evidence to give us confidence that inflation is on a sustainable and timely path back to 2% would risk undoing the progress we have made on inflation.”
Mester added that “the bigger risk would be to begin reducing the funds rate too early. And with labor markets and economic growth both being very solid, we do not need to take that risk …..”
A third voter, Atlanta Fed chief Raphael Bostic, took an even slower approach, foreseeing no rate cut until the fourth quarter. “If that trajectory slows down in terms of inflation, then we’re going to have to be more patient than I think many have expected,” said the erstwhile dove.
Richmond Fed President Thomas Barkin was similarly cautious Thursday: “I think it is smart for the Fed to take our time …. No one wants inflation to reemerge. And given a strong labor market, we have time for the clouds to clear before beginning the process of toggling rates down.”
By contrast, Chicago Fed President Austan Goolsbee, considered more “dovish,” opined Thursday that the January and February inflation “bumps” “should not knock us off the path back to target …
““(W)ith the federal funds rate range at 5-1/4 to 5-1/2 percent, our policy stance is restrictive,” he said. “Real interest rates are high by historical standards. So we need to be mindful of how long we want to stay in that posture if, as expected, we see continued progress getting inflation down…..”
“With the improvements in inflation we’ve seen over the past nine months, I see the risks to our inflation and employment mandates having moved into better balance,” Goolsbee went on. “ If we stay restrictive for too long, we will likely see the employment side of the mandate begin to deteriorate.
On the other hand, Minneapolis Fed President Neel Kashkari, once considered a “dove” himself, mused Thursday that the Fed might not be justified in cutting rates at all this year. “If we continue to see inflation moving sideways, then that would make me question whether we need to do those rate cuts at all. There’s a lot of momentum in the economy right now.”