Fed set to slow down on rate hikes again and debate how much further to go

“Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2 percent on a sustained basis,” Fed Vice Chair Lael Brainard said Thursday in Chicago. She didn’t spell out her preference for interest rates at the next meeting or in coming months, but other officials have been more explicit.

Both Lorie Logan and Patrick Harker, presidents of the Dallas and Philadelphia Fed banks and voters this year on monetary policy, backed slowing the pace of rate hikes, while supporting further tightening.

“I expect that we will raise rates a few more times this year, though, to my mind, the days of us raising them 75 basis points at a time have surely passed,” Harker told the New Jersey Bankers Annual Leadership Forum on Friday. “In my view, hikes of 25 basis points will be appropriate going forward.”

Another top official, New York Fed President John Williams, said Thursday that “monetary policy still has more work to do” to return inflation to 2 percent.

The message was further reinforced on Friday afternoon by Governor Christopher Waller, who’s been one of the Fed’s more hawkish officials. Waller said he favoured raising the rates by 25 basis points at the next meeting while continuing to tighten. His comments were the last on policy before the Fed enters a quiet period ahead of its upcoming two-day meeting.

Officials hiked by a half point last month to a target range of 4.25 percent to 4.5 percent, slowing the pace of rate increases after four straight 75 basis-point moves. They also projected rates rising to 5.1 percent in 2023, according to their median forecast, which will be next updated in March.

Investors see rates rising by a quarter point at the next meeting but peaking in a slightly lower range around 4.9 percent. That view has been reinforced by a recent run of benign readings on inflation suggesting that the Fed is winning the fight on prices, easing financial conditions as markets rally.

“What if financial conditions are easing because the supply side is healing?” said Julia Coronado, president of Macropolicy Perspectives LLC. “I would expect that by the March” forecast round “you would have some Fed officials moving closer to where the market is.”

Officials are starting to divide. Some officials see pandemic imbalances improving and want the data to dictate how much more action is needed. Others have a more hawkish outlook because they worry inflation will be sticky and require a sustained period of restrictive policy to insure against a resurgence in prices.

For now, no one is ready to call for a pause in the tightening cycle.

Recent US economic data are mostly in line with the gradual slowing of activity that officials had hoped for. But they insist their job isn’t done, with some saying that outright job losses are needed to get inflation back down to their 2 percent target.

Several remain committed to pushing rates above 5 percent as a form of risk management no matter what the near-term data is saying.

“You’d probably have to get over 5 percent to say with a straight face that we’ve got the right level of the policy rate that will continue to push inflation down during 2023,” St. Louis Fed President James Bullard said Wednesday. “We want to guarantee, to the extent we can, that inflation will come down and get back on a steady path toward the 2 percent target. And we don’t want to waver in that, because one of the problems in the 1970s is that inflation kept coming back just when you thought you killed it.”

Fed funds futures markets are pricing in just two more hikes this year, and break-even rates in Treasury Inflation Protected Securities have prices settling back to target by the end of the year. Bullard said he was skeptical of such an inflation “crash.”

Most Fed officials appear united around Powell’s framework that it will take a deceleration in the prices of core services other than housing to bring inflation back to 2 percent. That view is closely linked with reducing wage gains with rising unemployment. Fed officials forecast about a percentage point increase in the jobless rate in their December outlook.

“In order to achieve price stability I think that is going to require some loosening in the economy and the labor market.” Logan said in a question-and-answer period following her speech Wednesday in Austin, Texas. “And exactly how much, and the exact configuration of that, I think is highly uncertain.”

Brainard is one of the few officials who is offering a different perspective.

“It remains possible that a continued moderation in aggregate demand could facilitate continued easing in the labor market and reduction in inflation without a significant loss of employment,” Brainard said Thursday.

She didn’t spell out how high she favors raising rates. But she did cite “tentative” indications of decelerating wage gains, anchored inflation expectations, and scope for lower profit margins as forces that could also lower inflation in months ahead.

Logan, in her Austin remarks, also said she would rather risk management be responsive to data than lock in on a specific goal.

From 2016 to 2019, a period when the unemployment rate was below 5 percent, Powell’s “supercore” measure of CPI services, minus rents, averaged year-over-year gains of 2.3 percent. For 2022, the measure rose at a 6.2 percent rate.

Overall inflation, by the Fed’s preferred measure, ran at 5.5 percent for the 12 months through November compared with a 6.1 percent rate the prior month.

“We still don’t have enough evidence that says wage growth is going to evolve in a way that will be consistent with 2 percent inflation,” said Matthew Luzzetti, chief US economist at Deutsche Bank Securities Inc.