MNI INTERVIEW: Fed Likely Done, Cuts Possible Before Year-End

The Federal Reserve is most likely finished raising interest rates and it could be prompted to cut them before year-end if inflation falls sharply as it may well do, former Boston Fed research director Jeff Fuhrer told MNI.

“We’re probably getting to the end of rate hikes. I’d be surprised if they continue raising next time,” Fuhrer said in an interview. “Inflation has already started coming down – that has little to do with the Fed’s actions so far, it’s too soon.”

The Fed raised interest rates to a 5%-5.25% range and Fed Chair Jerome Powell hinted at a possible pause in hikes as early as the June meeting.

Fuhrer said that elevated but lagging shelter costs are adding about 2 percentage points to CPI, and once those pressures ebb the true pace of inflation will prove much more subdued than the 5.9% April reading.

“If shelter were doing something more normal, and there’s good reason to believe they will be, then the underlying rate of inflation is already in the 2.5% maybe 3% range,” Fuhrer said. (See MNI INTERVIEW: Services Peaking As Fed Hikes Gain Traction-ISM)

OVERCOOKED

If his expectation is correct that inflation will fall even more rapidly as the lagged effects of accumulated tightening are more directly felt on prices and the job market, then Fed policy is arguably already too tight, Fuhrer said.

“Rhere’s a significant risk that they’ve raised rates too much. They’ve really raised the risk of a slowdown,” he said.

That said, the economy could still skirt recession given a labor market that shows few signs of slowing significantly – with a larger-than-expected gain of 253,000 new jobs last month.

“It risks having a slightly less soft landing. I think they’ve misread the way inflation has worked in this cycle especially at the current juncture so they’ve probably already overdone it.”

RATE CUTS PLAUSIBLE

Despite assurances from Powell that the Fed does not expect to reverse course and start reducing interest rates any time soon, financial markets continue to predict as many as three cuts this year, starting as early as July.

Fuhrer said the bar for cuts is high given the Fed’s rhetoric about keeping rates higher for longer – but not insurmountable if inflation data move in the right direction.

“If they see that inflation really is coming down and we are really seeing signs of softness, I would not be deeply surprised if they decided to recalibrate with some cuts in rates,” he said.

“Powell’s saying their read is inflation is still going to be a little bit sticky and if that’s right it wouldn’t be appropriate for them to be easing in the next six to nine months. But if some of these signs that inflation is coming down quickly are ratified, month after month, and it looks like it’s coming down to the 2% to 3% range, then they might say how much more steam do they need to take out of the economy?”