–September Meeting Could Be Pivotal for Monetary Policy
By Steven K. Beckner
(MaceNews) – Judging from what Federal Reserve policymakers have been saying, a total of 100 basis points of additional short-term interest rate hikes is baked in the cake at the Fed’s upcoming Federal Open Market Committee meeting and the following one in late July.
The Labor Department’s report that the consumer prices rose a worse than expected 8.6% in May from a year ago (1.0% vs. April) reinforces their inclination to raise rates 50 points on June 15 and again on July 27.
Beyond that the path of rates is far less certain.
Fed officials have largely concurred on the likely policy strategy over the next few months, but they have sent very mixed signals about the second half and have emphasized the great uncertainty about the outlook for the economy and inflation.
In short, Chair Jerome Powell and his colleagues are keeping their options open. They will no doubt be provisionally discussing those options June 14-15, when they will also be compiling a fresh, quarterly Summary of Economic Projections, including revised federal funds rate projections.
After the FOMC raised the funds rate by 50 basis points at its May 3-4 meeting, Powell said further such moves would be “on the table” at the June 14-15 and late July meetings – a sentiment largely echoed by other officials.
These prospective combined increases would leave the federal funds rate in a 175-200 basis point target range after the July 26-27 meeting. Considering that the funds rate was in a zero to 25 basis point target range before the FOMC belatedly started raising it on March 16, that may seem like a lot of rate action, especially since the Fed has also stopped trying to hold down long-term interest rates by starting to shrink its balance sheet.
But a 175-200 basis point target range would still leave the funds rate shy of putative “neutral.” In their March SEP, FOMC participants estimated the “longer run” funds rate at 2.4% – a tenth less than in December, for unknown reasons. So, few, if any, Fed officials, or for that matter Fed watchers, think the FOMC has done enough to curb inflation, which is running at 6.3% – more than triple the Fed’s 2% target, as measured by the price index for personal consumption expenditures (PCE).
The question is how much higher rates need to go and at what pace.
After completing those two highly probable June and July 50 basis point rate hikes, it’s not hard to imagine very different policy courses, depending on the data – a more aggressive set of rate hikes; a slower pace of rate increases; or possibly a pause in the tightening process – even an eventual reversal.
Powell & Co. have repeatedly expressed their strong commitment to returning inflation to target. With that in mind, they have vowed to push the funds rate to at least “neutral” and, if necessary, beyond into restrictive territory.
Powell said the FOMC will “keep pushing” with rate hikes until it sees “clear and convincing evidence” inflation is heading back toward its 2% goal, even it means that unemployment ticks up “a few tenths,” and said the FOMC “won’t hesitate” to push rates above neutral if necessary.
“If we don’t see (evidence inflation is abating) we’ll have to consider moving more aggressively …,” Powell said, but added, “if we do, we’ll consider a slower pace.”
More recently, newly confirmed Vice Chair Lael Brainard asserted, “We’re certainly going to do what is necessary to bring inflation back down. That’s our No. 1 challenge right now. We are starting from a position of strength. The economy has a lot of momentum.”
Among other voters, Governor Christopher Waller said he “support(s) tightening policy by another 50 basis points for several meetings.”
Waller said his rate projections could vary depending on inflation and employment data but said market expectations of 250 basis points of tightening this year are “consistent with the FOMC’s commitment to get inflation back under control and, if we need to do more, we will ….”
Cleveland Fed President Loretta Mester, who estimated funds rate neutrality at 2 ½%, said, “in the current high inflation environment, the real fed funds rate remains very negative. So given economic conditions, ongoing increases in the fed funds rate are called for .…”
After raising rates “another 50 basis points at each of our next two meetings,” she said “the FOMC will then be well positioned to consider the appropriate pace at which to continue removing accommodation over the balance of the year and assess how high rates will need to go.”
St. Louis Fed President James Bullard said the FOMC “should try to get to 3.5% by the end of this year,” although he downplayed the possibility of 75 basis point rate hikes by saying “50 basis points is a good plan for now.”
But while Fed policymakers have been quite assertive about their determination to bring inflation under control, it’s important to recognize that they have continually emphasized that the outlook is “highly uncertain” and riddled with “intensified risks.” That can only be taken as meaning that policymakers have plenty of doubts about the appropriate rate path.
Powell and his colleagues have given themselves leeway to adjust policy depending on the behavior of inflation, saying they will raise rates more or less aggressively depending on whether or not inflation moderates.
One also has to assume that, as always, policy will be affected by the relative strength or weakness of the economy and financial conditions. After all, the Fed’s stated aim is to lower inflation by cooling demand to bring it back into balance with supply.
Clearly, there are scenarios in which the FOMC would proceed more slowly.
While declaring their resolve to raise rates as much as necessary to vanquish inflation, policymakers have opened the door to a less aggressive approach.
Powell himself allowed for ‘a slower pace” if inflation comes down in the second half. Mester said, “If by the September FOMC meeting, the monthly readings on inflation provide compelling evidence that inflation is moving down, then the pace of rate increases could slow, but if inflation has failed to moderate, then a faster pace of rate increases may be necessary.”
Kansas City Fed President Esther George said, “evidence that inflation is clearly decelerating will inform judgments about further tightening.”
The Fed’s operating assumption so far has been that the economy is “well- positioned,” i.e., strong enough, to withstand tightening. To the extent demand and in turn GDP growth weakens inflation is sure to follow, they believe. The Fed is also hoping that inflation expectations haven’t gotten irretrievably unanchored.
Even amid growing fears of recession, there are high hopes of a “soft landing” at the Fed, although Powell didn’t sound quite as optimistic about that in his last outing.
“It’s going to be a challenging task,” he conceded, pointing to increased uncertainties generated by the war in Ukraine and China’s anti-Covid lockdowns. He said there are “clearly paths” to a “soft landing” but hedged by saying the Fed may have to settle for a “softish landing” that could get “a little bumpy.”
Powell said, “a strong labor market … doesn’t mean the unemployment rate has to stay at 3.6%. You can still have a strong labor market if the unemployment rate were to move up a few ticks.”
But it’s not like the Fed has a choice, he suggested. “We have to slow growth to do (cool inflation) …. Growth has to move down for inflation to come down .…”
So far, though, hopes for a soft landing live on, despite the 1.5% first quarter GDP contraction. The May employment report likely encouraged those hopes. Non-farm payroll gains slowed but remained fairly large at 390,000. The unemployment rate remained at 3.6% despite increased labor force participation.
And average hourly earnings, about which officials had been concerned as a source of price pressure, showed further signs of decelerating. They rose 0.3% month-over-month instead of rising 0.4% as expected and were up 5.2% year-over-year — down from 5.6% in March.
The Institute for Supply Management’s May manufacturing and non-manufacturing surveys also pointed to slower but still substantial growth along with some softening in their price indices.
Other inflation readings have also been a bit more encouraging. After rising by 6.6% year over year in March, the headline PCE rose 6.3% in April. What’s more, the core PCE slowed from 5.3% in February to 4.9% in April. The core CPI has shown a similar pattern.
The Fed’s latest survey of economic conditions (the “beige book”) prepared for review at the upcoming FOMC meeting also seemed to support the soft landing thesis, finding tentative signs of moderating wage-price pressures along with economic cooling.
The beige book described growth as “continuing” but varying from “slight to modest” – a stepdown in pace from prior surveys. It said, “firms reported strong wage growth” “in a majority of Districts,” but said “most others reported moderate growth,” and “in a few Districts, firms noted that wage rate increases were leveling off or edging down.”
The latest beige book also sounded a softer tone on price inflation. “Most Districts noted that their contacts had reported strong or robust price increases – especially for input prices,” it said, but “three Districts observed that price increases for their own goods or services had moderated somewhat….”
The beige book said “about half of the Districts observed that many contacts maintained pricing power – passing costs on to clients and consumers, often with fuel surcharges.” But it added that “more than half of the Districts cited some customer pushback, such as smaller volume purchases or substitution of less expensive brands…”
Needless to say, Fed policymakers want to see considerably more evidence that inflation is moderating on both the wage and price fronts.
Soft landing presumptions, if validated, could lead to a pause in tightening and ultimately a reversal earlier than some might think.
Bullard, who is usually thought of as one of the more hawkish FOMC voters, was surprisingly explicit about that not long ago. By sometime next year, he said, “we could be lowering the policy rate because we got inflation under control.”
The only problem with soft landing premises is that inflation may turn out to be not as responsive to economic slowing as the Fed hopes. Having turned it loose by accommodating fiscal extravagance, inflation could prove to be stubbornly persistent even in the face of slower growth and tighter financial conditions. If higher inflationary expectations have become embedded after decades of being “anchored” at or below 2% and if therefore we’ve gotten ourselves back into a 1970s style stagflation, then the Fed could face a much tougher task than it now imagines.
For now, the consensus is that it’s much too soon for officials to conclude that their relatively modest amount of tightening is succeeding in reining in the worst inflation in 40 years at small economic cost. And, in fact, other than Atlanta Federal Reserve Bank President Raphael Bostic, they are not.
Bostic, who is not an FOMC voter this year, ventured recently that “a pause in September might make sense.” The comment helped fuel an impressive rally on Wall Street, but he got no support from other FOMC participants. Indeed, Brainard, who has hardly been known for hawksish proclivities over the years, took sharp exception by saying, “Right now, it’s very hard to see the case for a pause.”
That’s putting it mildly from the perspective of FOMC voters like Waller, who said he is “not taking 50 basis-point hikes off the table until I see inflation coming down closer to our 2% target. And, by the end of this year, I support having the policy rate at a level above neutral so that it is reducing demand for products and labor, bringing it more in line with supply and thus helping rein in inflation.”
But again, the outlook, domestically and globally, is uncertain enough that no one really knows where rates need to go. Coloring the monetary policy debate is an increasingly complicated labor market picture. Myriad statistics are subject to interpretation. This uncertainty has sometimes yielded strange, not to say contradictory Fedspeak.
The Sept. 20-21 FOMC meeting is looming larger and larger.