MNI INTERVIEW: High Bar For More Cuts As Neutral Nears-Kaplan

Federal Reserve officials should think twice before lowering interest rates again because borrowing costs are already close to neutral levels while inflation remains well above target, former Dallas Fed President Robert Kaplan told MNI. 

“The bar for further cuts for me goes up substantially because we're getting closer to neutral and, with inflation running above target, I want to have an extremely good reason for lowering the fed funds rate to what I think is about neutral,” said Kaplan, now vice chairman of Goldman Sachs, in an interview. 

The FOMC will need to analyze incoming data to make a “gametime” decision on whether to cut rates in December, said Kaplan, suggesting that he would be more inclined to pause. 

“The problem is that if inflation does not improve, and I think at least for the next six months there are more reasons to think it might back up a bit or go sideways or back up a bit and improve, then I really want to be convinced that this labor market weakening is more persistent and maybe even intensifying,” he said. (See MNI INTERVIEW: Tariff Price Boost Still Percolating-Schoenle)

The central bank has two main options for its December decision, said Kaplan. It could opt to deliver a dovish pause, where it keeps rates on hold but leaves open the possibility of further cuts if jobs weaken materially. Alternatively, policymakers could opt for a hawkish cut that suggests this is the last reduction for some time. 

The problem with the latter option, said Kaplan, is that it could leave policymakers offside if the employment picture firms into next year, as it well could. “If the labor market does firm, we’re in neutral. With inflation this much above target, I really don't want to be in neutral."

Kaplan sees the neutral rate at around 3.5-3.75%, not far from the current federal funds rate of 3.75-4%.

While economists believe most of boost to inflation from tariffs is already in the rearview mirror, Kaplan's business contacts indicate the bulk of the impact could be yet to come. "I think their view is you're going to see a bigger brunt into next year, because the destocking will have been exhausted."

SHUTDOWN DRAG

Kaplan said forthcoming data are likely to show added weakness because of the just-ended government shutdown, and the absence of survey information thus far had helped the case of Fed hawks by depriving doves of fresh evidence of job market weakness. 

“You want to use every bit of the time between now and December 9 to keep assessing what's really going on with the labor market and what's likely to go on,” said Kaplan.

He said the data vaccuum has been less relevant to the outlook than the actual drag on growth from the shutdown itself.  Business activity is generally sluggish at the moment, but tax incentives that will kick in early next year and deregulatory measures that are improving the backdrop should have a stimulatory effect, added Kaplan. 

FED INDEPENDENCE

As the Fed faces a leadership transition with the looming nomination of a new chair, Kaplan said the institution is well placed to resist any perceived threats to its independence. 

“The culture at the Fed right now by and large is very strong, and people are really trying to adhere to making the best judgment they can without regard to political influence or political considerations,” he said.

“The concern would be, if you had enough personnel changes – maybe more than just the chairman but others. I think the challenge for whoever is running the Fed and the team is to adhere to that ethic.”