MNI INTERVIEW: Fed Is Firmly On Hold For Some Time - Sheets

The Federal Reserve is likely to keep interest rates on hold for some time, with a higher and more prolonged oil price trajectory making a rise in interest rates more probable, the former director of the Division of International Finance at the Fed Board of Governors, Nathan Sheets, told MNI.

"I think they are firmly, firmly in wait and see mode," he said in an interview after the FOMC last week kept rates on hold for the third straight meeting and outgoing Chair Jerome Powell said the center of the Committee is moving toward a more neutral place. 

Sheets said the Fed's March SEP indicating one rate cut by the end of the year remains a reasonable benchmark. "If they cut as they project, it's going to be out a ways, toward the end of the year."

Whether disruption from the Iran war is large, broad, and durable enough to generate widespread supply chain stress is still uncertain, and oil prices would still have to rise, though those odds have climbed, he said. "If you're in that world with USD120 per barrel oil, the probability that the Fed will need to hike this year is substantial. I wouldn't put it over 50% but I'm not sure I would put it a lot below 50% in that scenario."

MAXIMUM OPTIONALITY

Powell flagged last week the central bank could remove its easing bias as soon the next meeting in June. Three regional Fed presidents dissented at the last meeting against the guidance. (See MNI INTERVIEW: Warsh Fed Won’t Manage To Ease Soon-Hubbard) 

Sheets said rate guidance in June will depend on the situation in the Middle East and oil prices. "It'll depend entirely on what's happening in the Middle East, where the price of oil is, what the inflation data are looking Like, and what the economy is looking like. Is it possible? Yes."

"But there's a lot of wood to chop. There's a lot of data that we're going to see," said Sheets, now global chief economist at Citigroup.

By retaining the easing bias in the rate guidance while also seeing several members of the FOMC dissent, Powell is arguably giving Warsh more room for maneuver  when he takes over at the Fed’s next meeting in June, Sheets said. 

"Maybe there's a case here that Powell's giving Warsh maximum optionality for the June meeting," he said. "With this strategy, you make the statement, but then you leave it to the Warsh Fed to decide what they want their bias to be." 

BALANCE SHEET TOOLS

Sheets, who was involved in helping establish and manage dollar swap lines with foreign central banks during the Global Financial Crisis, suggested that Warsh's Hidden PDF to Senate Democrats about such facilities are in keeping with the program's past, while also acknowledging the different roles of the Treasury Department and the Fed. 

"Treasury is the senior partner on international affairs in the US government, senior partner for U.S. economic affairs. The other paradigm is that the swap lines are tied critically to U.S. monetary policy," he said. 

Warsh's answers also flagged to senators his intent to review monetary policy implementation, including IORB and the ONRRP facility. 

"He does want to move to a smaller balance sheet, and there are mechanisms to achieve that smaller balance sheet, but it will require further fleshing out some of the existing tools like the standing repo facility," Sheets said. "I see as a critical part of being able to reduce the size of the balance sheet."