MNI INTERVIEW: Fed On Sidelines, Awaiting Clarity - Kaplan

The Federal Reserve looks set to keep interest rates on hold for now as officials seek evidence that U.S. inflation is back on a downward trend and try to gauge the effects of war in the Middle East, former Dallas Fed President Rob Kaplan told MNI.

"The thought at the Fed is, we'll move, but not until we see evidence of improvement. We don't want to anticipate improvement. What's happened this last two weeks with Iran just kind of reinforces, let's be patient," Kaplan said in an interview.

"They will be more open to moving than people think, but they need to see either real weakness in the labor market, which I think is less likely. More likely, you need to see improvement in headline inflation," he said, adding this could now take longer than policymakers had hoped.

On the flipside, base effects, continued Chinese manufacturing over-capacity, and AI adoption over the horizon are reasons to expect further disinflation, he said.

SEP NOISE

Before the Iran conflict, Kaplan was pretty optimistic about the U.S. economy in 2026, due to the continued AI capex boom, fiscal stimulus from tax refunds and incentives, and regulatory reform. The Fed "bought plenty of insurance" for the labor market in the fall of 2025, cutting interest rates by 75 basis points to the neutral level of interest, he said.

The former Dallas Fed president was eager to avoid speculating on the impact from the Persian Gulf conflict.

"If it lasts two weeks, that's one answer. If you tell me it lasts six or eight weeks, I have a different answer. And if it's three months or more, I have yet another answer," Kaplan said. (See: MNI INTERVIEW: Fed Pause Reinforced By Iran Shock - Fuhrer) 

The Fed's Summary of Economic Projections is a snapshot in time and next week's fresh release will contain even less signal than usual. "The SEP has the shelf life about the same as an unrefrigerated carton of milk," he said.

Fed officials will likely see weaker growth and higher inflation, Kaplan said. "Depending on what happens in the Middle East, all that can change in 30 days and they're very aware of that."

"I would still think that the median will be one or two cuts. That doesn't mean they'll do one or two cuts. I still think they'll project that in the out months later this year. You may start to see improvement in inflation, but they're going to have less conviction of that."

HOLD OR CUT

Kaplan said that he would have argued against the December cut if he were still on the committee, and he would be reluctant to go too far with guidance about two-sided risks in the FOMC statement. (See: MNI INTERVIEW: Fed On Pause Amid Two-Sided Risks - Rosengren) 

"I think the bar is very high to actually raise rates in the foreseeable future. I think it's more likely they'll either cut or they'll do nothing," said Kaplan, now vice chairman of Goldman Sachs.

"Is it two-sided right now? Maybe. But it's two sided with 90% likelihood the next move is down or pause, and maybe 10% or less the next move is up. And if I'm wrong, the 10% is too high."

He surmises the real neutral rate of interest is between 0.75% and 1%, and adds inflation of 2.6% or 2.7%. "What does that get you? That get's you a nominal neutral rate right now at 3.5% to 3.75%, exactly where the Fed is. That's the reason they're not moving."

CYCLICAL VS STRUCTURAL