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Federal Reserve officials are starting to take different views on how quickly to raise interest rates as they balance hot inflation with increasing stress in financial markets.
With the Fed’s target range now between 3% and 3.25% and just a few moves away from reaching the projected peak, officials are starting to talk differently about the urgency with which they need to get there.
Falcons like Cleveland Fed chief Loretta Mester say they must keep raising rates aggressively to win the battle against inflation even if that leads to a recession. Vice President Lael Brainard has offered a somewhat softer assessment, although he continues to stress the need to tighten policy.
Brainard’s speech on Friday, the first from the leadership of the Fed board since officials met last week, said policy will need to be tight for a while and avoid the risk of a premature withdrawal.
But he injected a note of caution about how fast they should go, as he discussed several ways the global cycle of rate hikes could affect the US economy.
His colleague from San Francisco, Mary Daly, also highlighted the cost of doing too much, as well as too little, to reduce prices.
His comments injected a slight variation into what has been a steady stream of insistence from regional Fed presidents declaring an unyielding determination to crush inflation.
The potential costs to the economy are already being telegraphed in the form of falling asset prices. The S&P 500 declined 9.3% in September in the biggest monthly decline since March 2020 as Covid-19 spread.
Bank of America Corp. says that credit stress is at a “critical threshold level” beyond which dysfunction begins. This is something the Fed wants to avoid because market breaks are difficult to control and can accelerate declines.
The splits among officials appeared in their forecasts released on September 21 that showed 8 officials estimated they would end the year with rates between 4% and 4.25%, while nine were a quarter point higher .
One of the dividing lines, said Derek Tang, an economist at LH Meyer in Washington, is the divergence of views on long-term inflation expectations, with those taking comfort in the stability of these indicators now saying that the committee can do step by step. progressive approach to reach maximum rates. Policymakers see it at 4.6% next year, according to their median estimate.
Brainard cautioned that it will take time for the full tightening to spread broadly across the economy, another way to argue for some patience from now on.
“Uncertainty is currently high and there is a range of estimates around the appropriate destination of the target range for the cycle,” he said at a conference hosted at the New York Fed on financial stability. “Proceeding deliberately and in a data-driven manner will allow us to learn how economic activity and inflation are adjusting to the cumulative tightening.”
This is in stark contrast to the Fed hawks. Indeed, Mester has argued aggressively against the downward shift to more deliberative policy, as officials have done in past tightening cycles when high uncertainty led the central bank to raise rates a quarter of point at the same time.
At a time when inflation is too high and the direction of inflation expectations is difficult to predict, overshooting is better than undershooting, says Mester.
“Some findings in the literature suggest that when policymakers face more uncertainty, either in their data or in their models, they should be more cautious in acting, that is, be more inertial in their responses,” he said in a September 26 speech. “Subsequent research has shown that this is not generally true.”
“It may be better for policymakers to act more aggressively because aggressive, preemptive action can prevent worst-case outcomes from occurring,” he added.
The debate over how quickly peak rates are reached is not a discussion about reversing course: No official is talking about easing quickly once they are there. Labor markets are strong, with forecasters estimating 250,000 more jobs added in September, while the latest inflation report was disappointing.
Commerce Department data on Friday showed the central bank’s preferred gauge rose 6.2% in the 12 months to August, down from 6.4% in July but defying expectations forecasters of further moderation up to 6%.
What ultimately determines the pace could be whether the markets stay orderly or not.
“They’ve made the decision that they’re going to tighten more rather than less, which certainly suggests that the risks are that they tighten too much. How will we see that? You’ll see it in financial conditions and market performance,” said Julia Coronado, founding partner from MacroPolicy Perspectives.
“I think they still underweight” the risk of chaotic market falls, he added. “When you say we’re determined to be the fastest car on the road, that really encourages positioning that’s one-way.”
(Add a comment from Coronado in the final paragraph)
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