MNI INTERVIEW: Fed Dec Pause Would Preserve Options - Sheets

The Federal Reserve should lean toward holding interest rates steady at its next meeting in December to continue to put downward pressure on inflation and keep its policy options open, the former director of the Division of International Finance at the Fed Board of Governors, Nathan Sheets, told MNI.

"I probably lean at this moment 60-40 to wanting to pause in December and wait and see where we land," Sheets said. If they cut, "I don't think that would be a mistake" but "its not something that can be taken back" if inflationary pressures build. 

"The Fed has missed its inflation target for four years in a row" and inflation is "going the wrong direction," Sheets said. "On the other hand, the labor market has softened" but is not collapsing. 

The FOMC will need to analyze incoming data after the government shutdown, which still could provide sufficienty clarity about the need for a cut at the next meeting, he said. (See: MNI INTERVIEW: High Bar For More Cuts As Neutral Nears-Kaplan) 

CLOSE CALL

Sheets said if he had been on the FOMC he would have voted for a cut in October. But he is concerned about the path for inflation. 

"With tariff inflation you tend to look through it, but you have to be careful with that narrative and see if it is necessarily true," he said. "Should you really be totally excluding it."

Excluding the effects from tariffs "feels to me a little aspirational," rather "than the Fed devising its monetary policy strategy to get it back," he said. A moderate degree of pressure on inflation is a reasonable argument. "But it's a close call. I lean toward sticking, but a cut would not be a huge mistake."

Sheets questions whether underlying inflation is really moving in the right direction. "I'm not so persuaded by non-shelter services. It's like Missouri. I want to see it. Show me," he said, referring to the state's famous sobriquet. "I'd like to see non-shelter services behaving better."

"A much more robust set of data and a much more robust capacity to be able to evaluate the economy in January is one reason I would feel a little more comfortable cutting in January. I might be even able to have a little bit of sense anecdotally as to whether I'm seeing a little bit perkier pass through of tariff inflation or not in January." (See: MNI INTERVIEW: More Fed Cuts Risk Inflation Spike-Weinberg) 

HARD TO REVERSE

Measures of activity have been pretty solid and another complication is the Fed is getting closer to the neutral rate of interest, he said. "It's a conflicted committee and that's all exacerbated by not having the data."

"If I get to January and I have already cut on incomplete data in December but now things are looking perkier on the inflation front, you can't hike. All I can do is pause," he said. "It's harder to take it back. One preserves optionality by remaining steady in December and it gives leverage on inflation."

Sheets also noted the risk that new policymakers on the FOMC next year will help to add a dovish posture. "That is a risk to the downside of lower rates."