MNI INTERVIEW: Fed Pause Reinforced By Iran Shock - Fuhrer 

Federal Reserve officials are likely to hunker down further in a wait-and-see mode for the next few months as they attempt to gauge the effects of a U.S. war with Iran that poses both the risk of an inflation resurgence and a threat to growth, former Boston Fed research director Jeffrey Fuhrer told MNI. 

He said the war raises inflation risk because of the shock to energy prices but at the same time it increases uncertainty at a time when businesses were already struggling to adapt to a new tariff regime, and could thus dampen investment. 

“I can't imagine that anybody on the committee has a firm view on how this is going to proceed. It's just too uncertain. But I think maybe with one or two exceptions, folks on the committee are going to be looking at this as a two-sided shock,” said Fuhrer in an interview. 

“I don't see that just yet, but we could see a serious downturn, and we could also see, because of the timing of these things, some surge in inflation, not super dramatic but uncomfortable from the Fed’s perspective.”

The former Fed staffer is worried about the narrow composition of U.S. economic growth, which he said leaves the expansion vulnerable. 

“We were fortunate last year to strike a balance with some employment and healthcare and with some investments in not just AI, but a couple of modest-sized sectors that kept the economy from tipping down. The question for this year is can we maintain that precarious balance?" he said. 

On the inflation front, the biggest risk is that prices pressures have already exceeded the Fed’s 2% target for several years, which has weakened the anchor of price expectations and raised doubts about the central bank’s commitment to its target. 

“If you can't convincingly and persistently get inflation down to 2% and it's been years now with a few ups and downs, more up recently than down, then I think you could be changing the norm that people think about for inflation,” he said. (See MNI POLICY: Fed Embraces Pause As Downside Job Risks Abate)

WARSH TRANSITION

As the Fed approaches a leadership transition with the nomination of Kevin Warsh to replace Chair Jerome Powell, Fuhrer said the best way for the new appointee to establish his credibility with the rest of the FOMC is to not push any ideas that are too out of consensus. 

Warsh argued in advance of his nomination that the Fed was holding back growth by not easing quickly enough, mistaking expansionary momentum for inflationary pressures. That has suggested to investors that he is inclined to cut rates when he takes the helm, though Fuhrer said it’s not that simple.

“If that doesn't seem like the right move for at least two thirds of the committee, he doesn't have the clout to pull the rest of the committee with him,” he said.  The best way for him to earn that credibility is “if he does what appears to be the right move for most folks on the committee. He'll earn trust if he can show himself to be a real chairperson whose job is to do what's right for the economy.”

BALANCE SHEET

Fuhrer also believes it will be difficult for Warsh to orchestrate a major reduction of the Fed’s balance sheet in short order, despite the nominee’s historical critiques of the central bank’s expanded market footprint. (See MNI: Warsh Wants Fed Out Of Treasury's Business)

“If he wants to push a gradual reduction in the balance sheet while they are roughly in neutral, he can get that through. But if he wants to move at all rapidly in a way that's really going to change long term rates, it's going to be a tough sell,” he said. 

Fuhrer also said the idea of Fed-Treasury Accord like the one Warsh has proposed “does not play well inside the Federal Reserve System, and for good reason.”