MNI INTERVIEW: Fed's Next Rate Move Could Be A Hike-Haslag

The Federal Reserve could have to raise interest rates if the price spike linked to the war in Iran proves more persistent, former Dallas Fed economist Joseph Haslag told MNI, adding that he thinks inflation will jump significantly over the next few months.

"There is some patience, but if we’re still in the same situation in three months, I would think that there’s probably a 50/50 chance that the next move is a hike,” Haslag, who now leads the Economics Department at Auburn University, said in an interview.

For the moment, financial markets are holding onto hopes for a swift resolution of the conflict and a reopening of the Strait of Hormuz, he noted.

But headline inflation could soon end up somewhere between 4%-5% while core inflation drifts higher to around 3.5%-4%, Haslag said.

“I think inflation expectations will be moved by the move in the inflation rate, and we’re all humbly looking to see how much pass through there is. The observable inflation rates are going to go up over the next few months,” he said. 

It’s likely that the policy rate is already below neutral with inflation back on the march, according to Haslag, though that doesn’t mean the Fed needs to react immediately. Policymakers could leave rates on hold while they wait to see how much the energy shock seeps through into other categories. 

“I don’t think the Fed has to respond. I think they’ve got a three-month grace period,” he said. (See MNI INTERVIEW: Fed Should Move To Neutral Bias Soon-Natalucci)

NEW LEADERSHIP

Against that backdrop, new Fed Chair Kevin Warsh faces a tough challenge in establishing his credibility as an inflation fighter, particularly after he made a case for lower interest rates in the run-up to his nomination.  

“I don't know how he's going to build a consensus if he doesn't come out with his bona fides as a hawk,” said Haslag. 

Fed officials have largely moved away from discussing rate cuts and have started to publicly contemplate the possibility of a rate hike. There is active discussion ahead of the June meeting on whether to drop the easing bias on rates. 

Minutes from the April meeting showed “a majority of participants” thought “some policy firming would likely become appropriate if inflation were to continue to run persistently above 2%.”

Haslag does agree with Warsh’s view that strong productivity gains associated with the AI boom could prove disinflationary. But he added that that does not support rate cuts right now. 

“Historically there's not a strong correlation between productivity gains and real interest rates,” he said. “If he gets too out of whack with real interest rates on risk-free returns, he's planting the seeds for inflation. And it just doesn’t seem like there’s a strong case for cutting rates, whether it's productivity or not.”

COMMUNICATIONS

Haslag is leery of Warsh’s proposals for sweeping communications changes, which could include everything from restricting the number of public speeches officials give to changing how the Fed publishes its macro and rate forecasts – or even scrapping these altogether. (See MNI POLICY: Warsh Could Reshape Fed On Rates, Communication)

“I think it’s dangerous to alter the communication infrastructure that’s been built up over the years,” he said.  “I like transparency, people like transparency from your institutions. My instincts tell me the infrastructure is about right and to change it is going to be confusing and will introduce more volatility in a market that doesn’t need any more volatility.”