By Steven K. Beckner
(MaceNews) – Federal Reserve Governor Christopher Waller said Friday that the Fed still needs to raise short-term interest rates further and leave them high for longer than many anticipate, but said tightening bank credit will likely lessen how much monetary policy will need to be tightened.
Although headline inflation numbers have come down, core inflation has merely “gone sideways,” which means “monetary policy needs to be tightened further” to reduce inflation to the Fed’s 2% target, Waller told the Graybar National Training Conference in San Antonio, Texas.
He said he will be watching to see how much banks tighten “non-price” terms of credit to see how much the Fed needs to increase the “price” of credit, i.e., interest rates.
Before the failure of the SVB and other banks, Waller said he was leaning toward projecting that the federal funds rate would need to go to at least 5 ½% this year, but in wake of bank stresses, he said “we don’t have to do as much.”
Waller joined a unanimous FOMC vote on March 22 to increase the federal funds rate 25 basis point to a target range of 4.75% to 5.0% for the second straight meeting.
Two weeks earlier, Fed watchers had put high odds on a 50 basis point rate hike, and Fed officials were publicly leaning toward raising their rate projections. But then a series of bank failures and emergency rescues made policymakers reluctant to raise rates more aggressively.
As minutes of the March 21-22 meeting put it, “In discussing the policy outlook, participants observed that inflation remained much too high and that the labor market remained tight; as a result, they anticipated that some additional policy firming may be appropriate to attain a sufficiently restrictive policy stance to return inflation to 2 percent over time.”
However, the minutes added, “Many participants noted that the likely effects of recent banking-sector developments on economic activity and inflation had led them to lower their assessments of the federal funds rate target range that would be sufficiently restrictive compared with assessments based solely on the recent economic data…..”
Even officials who had been inclined to raise the funds rate by 50 basis points felt that, “due to the potential for banking-sector developments to tighten financial conditions and to weigh on economic activity and inflation, they judged it prudent to increase the target range by a smaller increment at this meeting,” according to the minutes, which also say some considered “hold(ing) the target range steady,”
Instead of raising rate projections, as had been expected before the banking panic, FOMC participants retained their December projection of a median 5.1% (5.0% to 5.25%) by the end of 2023.
Waller, who has been one of the more hawkish voices among FOMC voters since joining the Board of Governors in December 2020, continued to sound that way Friday, but tempered his hawkishness with observations about private credit tightening.
Alluding to recent reports on the consumer price index, he said inflation “is still much too high and so my job is not done.”
The Labor Department reported earlier this week that the overall CPI rose 0.1% in March and 5.0% from a year earlier, down from 0.4% and 6% in February. But the core CPI, excluding volatile food and energy. Was up 0.4% and 5.6% from a year ago.
“I interpret these data as indicating that we haven’t made much progress on our inflation goal, which leaves me at about the same place on the economic outlook that I was at the last FOMC meeting, and on the same path for monetary policy,” Waller said in prepared remarks.
“Because financial conditions have not significantly tightened, the labor market continues to be strong and quite tight, and inflation is far above target, so monetary policy needs to be tightened further,” he continued. “How much further will depend on incoming data on inflation, the real economy, and the extent of tightening credit conditions.”
“Another implication from my outlook and the slow progress lately is that, as of now, monetary policy will need to remain tight for a substantial period of time, and longer than markets anticipate,” Waller went on, adding that because there is still more than two weeks until the FOMC meets again May 2-3, he will “stand ready to adjust my stance based on what we learn about the economy, including about lending conditions….”
“I would welcome signs of moderating demand, but until they appear and I see inflation moving meaningfully and persistently down toward our 2% target, I believe there is still work to do,” he declared.
In his speech and in response to questions, Waller minimized the Fed’s progress on inflation.
“Inflation moderated in the second half of 2022, but that progress more or less stalled toward the end of the year, and inflation remains far above the FOMC’s target of 2%…,” he said. “Since December of 2021, core inflation has basically moved sideways with no apparent downward movement. So, despite some encouraging news on a slowing in housing costs, core inflation does not show much improvement and remains far above our 2% inflation target.”
Waller attributed the lack of progress on core inflation to the strength of the economy and the tightness of labor markets, which he alleged has perpetuated an imbalance of supply and demand.
“(T)he data in hand for the first quarter of 2023 continue to surprise me, with stronger growth and job creation than I expected late last year…,” he said, pointing to the Atlanta Federal Reserve Bank’s estimate that the gross domestic product grew by 2.2% in the first quarter.
“This growth would mean that, so far, tighter monetary policy and credit conditions are not doing much to restrain aggregate demand.”
Prior to the bank failures, Waller said economic data were “extremely hot,” and ”the economy was not showing any signs of slowing down,” leading him to believe that “the terminal (federal funds) rate would have to be much higher than projected in December” (5.1%).
“I started to think we would have to go to 5 ½ or higher to deal with it,” he said.
But since the bank failures have intensified a tightening of bank credit which he said had already been underway, Waller said he has concluded “we don’t have to do as much on the price (rate) side.”
He said tightening bank credit “kept me from pushing up my terminal rate (projection)” in the March 22 “dot plot” and caused him to “leave it where it was in December.”
“We’re going to let (credit tightening)…do the work for us…so we don’t have to raise rates as much,” he elaborated.
However, Waller suggested the jury is out on how much bank credit tightening will offset the need for Fed rate hikes.
“The failure of SVB and Signature Bank and related developments might have solidified and pulled forward factors that were already working to tighten lending conditions, or it may be that credit conditions will now be even tighter than they were on track to be,” he began. “I say this because, all else equal, a significant tightening of credit conditions could obviate the need for some additional monetary policy tightening.”
However, he added, “making such a judgment is difficult, especially in real time.”
Waller said he will be closely watching “non-price” terms of credit, i.e. how much more difficult banks make it to qualify for loans, to determine how much more the Fed needs to do.
In response to a question about the reserve currency status of the U.S. dollar, Waller said he doesn’t see “any serious threat” to the dollar’s predominant role, so long as it preserves the rule of law, property rights, deep capital markets and “relatively stable political and policy institutions.”
Waller’s comments come at the end of a week in which other FOMC voters expressed varying views on the economic and monetary policy outlook.
Chicago Federal Reserve Bank President Austan Goolsbee said “we’ve been tightening financial conditions to bring inflation down, so if the response to recent banking
problems leads to financial tightening, monetary policy has to do less.” He cited estimates that bank credit tightening “ might amount to raising the funds rate by something in the range of 25 to 75 basis points.”
“Given how uncertainty abounds about where these financial headwinds are going, I think we need to be cautious. We should gather further data and be careful about raising rates too aggressively until we see how much work the headwinds are doing for us in getting down inflation…..
Philadelphia Fed President Patrick Harker pointed to receding inflation and suggested the Fed may not need to raise rates further. “Since the full impact of monetary policy actions can take as much as 18 months to work its way through the economy, we will continue to look closely at available data to determine what, if any, additional actions we may need to take.”
Minneapolis Fed President Neel Kashkari said, “It could be that our monetary policy actions and the tightening of credit conditions because of this banking stress leads to an economic downturn. That might even lead to a recession.”
But Kashkari added, “We need to get inflation down. … If we were to fail to do that, then your job prospects would be really hard.” He said he expects inflation to fall to “the mid-threes” by the end of the year.