MNI INTERVIEW: Fed Easing Constrained By High Inflation-Sahm

The Federal Reserve is limited in how much it can cut interest rates given a lack of progress in bringing inflation down, former central bank economist Claudia Sahm told MNI. 

Sahm, an expert on labor market turning points, said policymakers are right to be concerned about downside risks to employment, but must also remain mindful of price pressures that have not receded for some time.  

“I think it's appropriate for the Fed to cut right now, saying that given the data, we've got to be putting more emphasis on the employment risk,” she said in an interview Monday. “But certainly the Fed should continue to reinforce that there's inflation risk here. Getting stuck at 3%, that could be a real scenario. We really haven’t made a lot of progress in the last year, year-and-a-half.”

She believes a good portion of recent labor market weakness is structural and related to immigration restrictions and deportations.  

“I do look at the jobs numbers and see a big role for labor supply, and for trend growth. A lot of that is just a dramatic slowing in immigration,” she said. (See MNI INTERVIEW: US Job Market At Potential Pivot Point - Shin)

TOO SOON TO GET NEUTRAL

Sahm said the Fed’s SEP will be on a “knife edge” between three and two cuts for 2025, but argues the bigger disconnect between financial market expectations and Fed officials’ views will come next year. 

“The markets have the Fed being in kind of a neutral position next year. I think moving towards neutral is appropriate, given the risk,” Sahm added. (See MNI INTERVIEW: Fed To Cut Every Meeting To End Year - Bullard)

“There is a good reason to expect inflation to start moving down as a baseline, but it's not going to happen overnight. And I think as long as inflation is still elevated, and particularly now, like when it's not even moving in the right direction, they need to be careful about getting back to neutral before you've had the inflation recalibrated.” 

This means the Fed’s rate-cutting cycle could be halting rather than sequential, as many investors expect. (See MNI INTERVIEW: Powell Won't Signal String Of Fed Cuts-Lockhart)

“It's fine to say they were going to start some insurance cuts now, because we're concerned about the labor market, but I could see another data cycle where we get more concerned about inflation,” said Sahm, also a former senior economist at the White House Council of Economic Advisers. “This really is the setup for businesses to embed a higher inflation rate. It really looks like a de-anchoring event.”

A DIFFERENT FED 

At the same time, Sahm said, markets might have good reason to ignore what the Fed’s projections say about next year, given looming personnel changes, including the appointment of a White House official to the board of governors, the attempt to fire Governor Lisa Cook, and the ongoing search for a replacement to Fed Chair Jerome Powell.  

“I’m not convinced we’re going to have the same kind of Fed next year,” she said.

She noted that President Donald Trump and his team have made no secret about their desire to control Fed policy more directly, and are taking steps toward doing this by installing CEA Chair Stephen Miran at the board while trying to fire Cook. 

“Trump has made it very clear he wants ultra-low interest rates and Bessent has made it very clear they are interested in the ten-year. And the Fed has tools for both of those. If the president controls the Fed, I fully expect the federal funds rate to be very low in the 1-2% range. I imagine there would be some adjustment in the markets, and then they’ll go after the long end.”

The most likely economic outcome of these policies would be persistently higher inflation, Sahm said. 

“Inflation expectations, if you think of something like breakevens, they are going to move. You’re going to run this economy too hot, the expectation then is you end up with inflation,” she said.