MNI INTERVIEW: Fed Won't Hike Yet But It Should, Says Hoenig

The Federal Reserve will likely refrain from raising interest rates until at least its September meeting, even though elevated price pressures and an intractable fiscal outlook warrant immediate tightening, former Kansas City Fed President Thomas Hoenig told MNI.  

Hoenig believes this week’s FOMC meeting is set to conclude with rates on hold again, in part because softer June inflation figures gave officials some breathing room. 

“I don’t think they will hike,” he said in an interview. “The June inflation numbers came in much more favorably than we thought they would. Core inflation also came down pretty significantly, and we're now at least in a pause in the war.”

Hawkish dissents in favor of a hike are a possibility, said Hoenig. But dovish policymakers will argue that the Fed can wait to see whether July and August numbers continue the improvement or reverse course, while the increase in Treasury yields could also provide fodder for them to argue that financial conditions have already tightened somewhat in recent weeks, he said. 

 The Fed could then choose to hike in September, he added. 

SURPRISE HIKE

A surprise rate hike this week would help Chairman Kevin Warsh burnish his inflation-fighting credentials, but it is probably not in the cards, said Hoenig. “I would love to see that. But I’m not going to see it,” he said.

Hoenig pushed back against the idea that the Fed can look through the current bout of inflation as the result of temporary supply shocks. (See MNI POLICY: Fed Inclined To Hike Despite CPI Breathing Room)

"That's fooling yourself. That's wilful blindness," said Hoenig. "What is the most common thing you hear today? The affordability problem."

FISCAL FRAGILITY

One of the biggest factors preventing the Fed from meeting its 2% price target, Hoenig said, is a ballooning budget deficit that he sees as inherently inflationary.  

“Kevin Warsh and the FOMC have a real dilemma on their hands. It's going to be painful either way. If they choose to delay too long on the rate increase and the slowing of the balance sheet growth more, then you will only feed the inflation dragon because one thing that isn't going to slow down is the growth in the debt, the deficit,” said Hoenig, now a distinguished senior fellow at the Mercatus Center at George Mason University. 

“The deficit will be another USD2 trillion. It has to be funded. So you're going to have enormous pressure, either on helping finance it through open market QE of some form, or you're going to see inflation – asset inflation, for sure, even continued general price inflation.”

For that reason, Hoenig thinks Warsh should buck a central Fed convention, which is not commenting on fiscal matters.

“You're going to have to take the approach of saying to the Congress of the United States, we are not going to monetize your debt any further,” he said. 

TARGET DOUBTS

As things stand now, with inflation above target for more than five years, there are growing doubts among consumers and investors about the central bank’s commitment to the 2% inflation target, said Hoenig. 

“They don't even know what it is anymore. I think that's an unfortunate fact because now we're not bound by this,” he said.