MNI INTERVIEW: Fed Hike Still Unlikely Base Case - Lockhart

Higher oil prices and supply chain disruptions have raised the risk that the Federal Reserve tightens policy, but an interest rate hike remains nobody's base case as yet, former Atlanta Fed President Dennis Lockhart told MNI. 

"It biases the committee to stay steady and watchful, to wait and see," he said in an interview, adding committee forecasts this week are unlikely to shift significantly. 

For incoming Fed chair Kevin Warsh, who will be under pressure from President Donald Trump to cut interest rates, "the unique new factors related to the Iran war and energy prices could very well give him aircover to not act on interest rates in an early meeting," Lockhart said. 

Warsh has argued that an AI-driven surge in productivity justifies lower interest rates, but the FOMC is more inclined to hold rates steady on concerns that inflation has been stuck around 3%. Several policymakers in January wanted the Fed's policy statement to explicitly state that hikes may be appropriate if inflation remains at above-target levels. 

"If the Fed's stance on hikes before the war was 'we never take an option off the table,' now it'll be a bit louder saying, 'don’t take it off the table as an option,'" Lockhart said. (See MNI INTERVIEW: Oil Prices Won't Disrupt Fed Pause - Bullard)

INFLATION CONCERNS

A scenario in which the war is prolonged and the Strait of Hormuz shut for some time would have worrisome impacts on consumer confidence and inflation expectations, which could shift the Fed's reaction function even if the economy shows resilience, Lockhart said. 

"After five years of having not met the inflation target, I think the committee ought to be concerned that another year, two years or three years, begins to corrode credibility and affect inflation expectations," he said. "Gasoline prices probably have more psychological impact on consumers than any other single price." (See: MNI INTERVIEW: US Price Expectations Jump On Iran War - UMich)

Already some Fed rate-setters doubt tariff effects have completely played through to the economy, and the Supreme Court's ruling that Trump's sweeping global tariffs are illegal, along with the 150-day expiry, adds to that uncertainty, Lockhart said. 

The Fed reacts to a stagflationary tradeoff by gauging the degree of deterioration of its price stability mandate relative to its other mandate for maximum employment and then deciding which requires priority treatment, Lockhart said. 

So far, the U.S. labor market appears to have stabilized near full employment, and while cooling and showing some fragility, a worse-than-expected February report hasn't yet shifted that narrative. 

"That has given some license to the inflation hawks on the committee to pretty strongly prioritize inflation now."