— Rate Hike Sentiment Rising, But Most Inclined to Be Patient
— Easing Bias Seems Increasingly Likely To Go
By Steven K. Beckner
(MaceNews) – Federal Reserve officials leaned half heartedly toward a potential tightening of monetary policy this week, as they struggled to keep up with the vicissitudes of the Iran conflict and its impact on energy markets and, prospectively, on the economy.
Officials have given no indication they’ll be ready to change rates at the June 16-17 meeting of the Fed’s policymaking Federal Open Market Committee, Kevin Warsh’s first as chairman. But their comments suggest it’s quite possible the FOMC will abandon the easing bias it has had in its policy statement since December, thus setting the stage for a potential future shift to tightening.
Officials such as Fed Governor Michael Barr and Cleveland Federal Reserve Bank President Beth Hammack have presented alternate scenarios in which the FOMC might conceivably want to either ease or tighten policy, with the letter increasingly seen, regrettably, as the most likely option.
For now, officials see a third scenario – an indefinite stay at current rates – as appropriate. For how long depends primarily on whether inflation worsens or moderates.
Officials have made clear they intend to look closely at the May employment report when it is released Friday morning to see how the Fed is doing on its “maximum employment” mandate.
But ahead of the report, past data have led most officials to see labor markets as relatively solid and unemployment historically low. Most recently, that view was seemingly vindicated by the ADP report that private payrolls grew by 122,000 in May.
By contrast, there is no denying how the Fed is doing on the other side of its dual mandate. Inflation, as measured by the price index for personal consumption expenditures (PCE), rose 3.8% year-over-year in April (3.2% core), and has exceeded the Fed’s 2% target for going on six years.
So most officials see the “balance of risks” as tilted decisively toward inflation. They simply aren’t yet ready to act on that predisposition, holding out hope that inflation will subside as and when tariff and oil price effects wind down.
Since its last rate cut on Dec. 10, the FOMC majority has taken the position that there can be no additional rate cuts until inflation decelerates unless labor markets weaken unexpectedly, and increasingly officials are talking about possibly needing to raise rates if labor markets remain sound.
There had been some hope for a return of disinflation last week, when the U.S. and Iran seemed on the verge of a settlement that would end the conflict and reopen the Strait of Hormuz. Oil, which had gone as high as $126 per barrel, fell below $87, but this week oil rebounded by 10% as hopes for a cessation of Middle East hostilities diminished.
As a result, policymakers find themselves in a prickly situation.
Kansas City Fed President Jeff Schmid said Thursday it is important to get inflation back down to the Fed’s 2% target, but said he and his Fed colleagues don’t want to “push the economy into recession.” He said they are asking whether they need to be “patient” about raising rates.
A cautious San Francisco Fed President Mary Daly said Thursday that the FOMC is “prepared to respond either way” to economic developments and expressed wariness about providing “forward guidance” that could end up “misguiding” the public and markets.
Richmond Fed President Tom Barkin repeated his belief Thursday that “the Fed is well positioned to respond as appropriate” as the FOMC assess the economic impacts of the Middle East crisis.
New York Federal Reserve Bank President John Williams, usually a reliable barometer of mainstream Fed thinking, defended the status quo Wednesday, saying “Monetary policy is exactly in the right place. I don’t see any need to raise or lower interest rates right now.”
But the FOMC vice chairman made clear the easing bias can’t last much longer: “I don’t think forward guidance is particularly helpful right now in terms of trying to communicate monetary policy. I don’t see an obvious argument that we should change interest rates, but I also don’t see an obvious kind of direction where we would go in the future.”
Barr, who was also talking in terms of different policy scenarios Wednesday, said, “We’re in a good place in terms of our policy right now to wait and see to actively monitor which of these paths we may be on.”
“My own view is it’s likely to stay there for quite some time as we wait to see how this plays out,” Barr said, but he added that in a scenario of continued inflation pressure, “We might actually have to raise rates.”
Dallas Fed President Lorie Logan sounded more inclined to tighten policy Wednesday, After pointing to “strong’ economic activity and to low and “stable” labor markets, she said, “These conditions indicate that monetary policy is not restraining the economy. I am increasingly concerned that higher interest rates could be necessary later this year to fully restore price stability and appropriately balance both sides of the Fed’s dual mandate.”
Hammack also leaned gently toward eventual tightening Tuesday. “For today, it’s reasonable to keep rates steady given the uncertainties around the economic outlook,” she said. “But if recent trends continue, it may soon be appropriate to act.”
The FOMC left the funds rate in a target range of 3.5% to 3.75% on April 29. But three Federal Reserve Bank Presidents (Hammack, Logan and Minneapolis Fed President Neel Kashkari) dissented in favor of removing from the policy statement this sentence: “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.” That language, introduced when the FOMC last cut rates on Dec. 10, conveyed an easing bias.
Minutes of the last FOMC meeting revealed that “many participants” wanted to drop the easing bias. And they reported that “a majority of participants highlighted …. that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2%.”
Officials this week were reluctant to go further and call outright for rate hikes in the near-term, but that contingency seemed to be a growing possibility on many officials’ minds.
Daly steered clear Thursday of saying where monetary policy is headed, but echoed others in saying it is in a good place for now.
“We are prepared to respond either way, whatever the economy brings,” Daly told a Bloomberg Tech conference in San Francisco.
She implied the FOMC should drop its easing bias, saying, “I think giving more forward guidance about what’s possible could be misguiding in the end, because we just have to wait for the economy to evolve.”
Schmid, usually thought of as one of the more “hawkish” Fed presidents, sounded more tentative Thursday in assessing what the FOMC ought to do.
Asked about the biggest risk facing the economy, he replied, “right now it’s about inflation.”
Noting that inflation has been above target for over five years and that the Fed was having trouble getting it down to 2% even before the Iran war, he told an economic forum sponsored by his Bank in Hochatown, Oklahoma.
But he said the Fed is trying to hit its inflation target “without pushing the economy into recession.”
Schmid said Fed officials are asking themselves, “Do we stay patient on rates?” With inflation now above 3 ½%, they are asking, “is it temporary…or do we act? Is now the time to raise rates a quarter or two and see if we can tamp this thing down..every month?”
“That’s the nature of our discussion” at every meeting, he said.
Whatever the FOMC ultimately does with rates, Schmid said, “We want it to be a net positive for the American people (and) not do any harm unnecessarily.”
Williams said Wednesday that, monetary policy is “exactly in the right place,” with “(no) need to raise or lower interest rates right now.”
But Williams spoke warily of inflation and inflation expectations on Yahoo Finance. While tariff and oil price increases should have “more of a one-time kind of effect,” he said he is watching for signs that inflation is “getting more persistently embedded.”
“I’m not seeing that yet, but definitely there’s a risk of that given how much of a kind of a boost to inflation we’re seeing,” he said.
Williams went on to say that inflation risks have increased “significantly,” while at the same time risks to employment have “edged down.”
“I don’t think forward guidance is particularly helpful right now in terms of trying to communicate monetary policy,” Williams said. “I don’t see an obvious argument that we should change interest rates, but I also don’t see an obvious kind of direction where we would go in the future.”
Barr echoed Williams and others Wednesday in saying “we’re in a good place in terms of our policy right now to wait and see to actively monitor which of these paths we may be on,” and he said “ it’s likely to stay there for quite some time as we wait to see how this plays out.”
But Barr warned that a scenario of persistently elevated inflation could force the FOMC to tighten policy.
“I think we’re in a tough spot in the sense that these shocks — tariffs, and energy — have continued to put pressure on inflation, and if you look at the economy right now..we’re not near the target we need to be, 2%, and in some measures we’re drifting away form it with oil and tariffs,” he told a Washington conference of the Community Development Bankers Association.
“We want to be sure before take our next step,” Barr said. “In one scenario..one time price effects, raise the level of prices but don’t create inflation dynamics…(then) should see inflation coming back down towards target.. (but) we haven’t seen it yet…if that’s the case we can probably hold rates steady for awhile..as (price shocks) play through… eventually come to a place of cutting rates … . We’re not there now.
However, he said, “If you think of another path…(where) shocks are bleeding through more broadly into the economy .. (Fed would) start to worry more about inflation…. The risk, if we see that second scenario, is that we might actually have to raise rates.”
Logan, one of those who dissented against keeping the easing bias at the last FOMC meeting, was more hawkish than most in Wednesday remarks at The University of Texas at El Paso, as she focused far more on inflation and inflation expectations than on threats to the economy. .
“Above-target inflation can become entrenched if it persists too long,” she warned. “Inflation expectations would make it more costly to restore price stability. I am closely watching movements in market prices for short-term and long-term inflation compensation, as well as surveys of inflation expectations.”
Logan said “economic activity remains strong” and “the labor market appears stable and broadly balanced.” What’s more, “Financial conditions are accommodative.”
“These conditions indicate that monetary policy is not restraining the economy,” she concluded. “I am increasingly concerned that higher interest rates could be necessary later this year to fully restore price stability and appropriately balance both sides of the Fed’s dual mandate.”
Hammack, another dissenter, also sounded the alarm about inflation Tuesday
“The longer inflation remains above our goal, the greater the risk that it feeds into expectations and becomes embedded in wages, contracts, and pricing behavior,” she told the City Club of Cleveland. This is why I often use the phrase ‘in a timely fashion’ when I speak of returning inflation to our objective.”
Hammack said “sharp increases in oil prices can pose a challenge to monetary policy. They raise production costs for many goods that derive from oil, and rising gasoline prices increase transportation costs. These forces put upward pressure on the prices of many goods and services, challenging the inflation side of our mandate.”
She said higher energy costs also pose risks to employment, because they “can slow consumer spending and, in turn, economic activity and employment growth.”
That presents the Fed with a dilemma, according to Hammack. “While higher inflation usually calls for more restrictive monetary policy, a softer labor market usually calls for more accommodative monetary policy. To balance these two outcomes, it’s sometimes best for policymakers to ‘look through’ an oil shock by holding interest rates steady.”
But it was plain she sees the greatest risks on the inflation side. for while “the economy has been resilient so far,” and while labor market data “point to resilience and stability,” inflation poses a greater threat in her view.
“By contrast, the picture for inflation is not encouraging,” said Hammack. “Inflation is too high and is moving higher.” Even after stripping out energy and food, core PCE inflation is “also well above our objective and well above levels from six months or a year ago.”
She said the Fed needs to be “forward-looking when setting interest rates” and therefore presented different scenarios.
“Under one scenario, it’s possible that an extended period of high oil prices and supply chain pressures will boost inflation while eventually weighing on growth and the labor market,” she said. “In this case, policy could remain on hold for some time to balance weaker prospects for the labor market with elevated inflation.”
“Alternatively, a sharper downturn in spending and the labor market could warrant a more accommodative stance of policy, although I see this as less likely,” Hammack continued.
However, she went on, “there is a growing risk that inflation could remain elevated if energy costs do not come down quickly and if businesses feel they have no choice other than to raise prices.”
“If inflation persists at an elevated rate, then more restrictive monetary policy could well be needed to bring inflation back to 2 percent in a timely fashion,” she added.
Like many of her colleagues, Hammack placed heavy emphasis on inflation expectations. “With the economy now in its sixth year of elevated inflation, consumers, businesses, and financial markets may start to build in expectations for higher future inflation.”
“Increases in inflation expectations that threaten our goal warrant taking decisive action,” she added.
Hammack suggested there is no urgency to move policy in either direction. “For today, it’s reasonable to keep rates steady given the uncertainties around the economic outlook.”
“But if recent trends continue, it may soon be appropriate to act,” she continued. “Based on the data, I’m more concerned about the growing risks of persistently elevated inflation than the risks to full employment and also that monetary policy may not be sufficiently restrictive to bring inflation down to 2%t.”
“If we wait for definitive evidence that high inflation has become embedded in the economy, it may require larger policy adjustments, at greater cost,” she added.
Barkin took his usual balanced approach Thursday morning in talking about how the Fed should respond to the impact of the Iran war.
So far, he said the economy “remains resilient,” but as the war continues, “the extent of its impact will depend on how long it lasts and how long it takes to rebuild supply chains and manufacturing capacity once it’s resolved.”
Barkin, repeating late May remarks in Raleigh in Loudon County, Va., said the “approach of looking through supply shocks has worked well for a generation thanks to what economists call ‘anchored long-term inflation expectations.’”
But with supply shocks seemingly becoming “more frequent,” he said the Fed’s job cold become “more challenging conditions.”
Whether the Fed will “have the luxury of riding out all the waves that come our way” will depend on “how much businesses, consumers, and inflation expectations can take,” he said. “First, will businesses get queasy? … Second, will consumers abandon ship? Thus far, they’ve continued to spend.”
Finally, Barkin asked, “How secure is the inflation expectations anchor?” So far, he said long-term inflation expectations “remain well anchored.” But he added, “With inflation above our 2% target for over five years now, it’s worth asking whether the cumulative impact of so many waves risks loosening the anchor.”
“The answers to those three questions will determine whether the Fed still has the luxury to look through supply shocks,” he added.
Barkin said the FOMC’s decision to hold rates st eady on April 29 “made sense to give ourselves some time before setting sail.”
“Going forward, I wouldn’t be surprised if we continue to see rough seas that pressure the employment side of our mandate, the inflation side of our mandate, or conceivably both,” he continued. “If we do, the Fed is well positioned to respond as appropriate.”