May 24, 2022
Here’s How the Fed Might Adopt Bostic’s Rate Pause in September
(Bloomberg) -- Federal Reserve Bank of Atlanta President Raphael Bostic has cracked open the door to discussing a September pause in the central bank’s aggressive rate hikes -- a move that will only be on the table if inflation falls more than expected over the summer.
The Federal Open Market Committee is expected to raise interest rates by a half point in June and July, boosting its policy rate to a 1.75% to 2% target range. That would lift it to the lower edge of the Fed’s estimate of the neutral rate that neither stimulates nor restricts growth. By September, the Fed will also be shrinking its balance sheet by $95 billion a month, which is a second tool that officials are using to tighten policy.
Pausing at the Fed’s September 20-21 meeting -- which Bostic said on Monday might make “sense” -- will probably require two tough conditions to be met: inflation slowing meaningfully and signs that the US economy is cooling enough to reduce future price pressures.
Chair Jerome Powell has already set a high bar for policy makers to put their plans on hold, vowing on May 17 that officials will keep raising interest rates until there is “clear and convincing” evidence that inflation is in retreat. Yet policy makers will also look for a softening job market for signs that price pressures will keep ebbing.
“The $64,000 question for markets is what market and economic conditions would push the Fed to pause,” said UBS strategist Matthew Mish. “They need to be able to say confidently that inflation is coming down. Obviously they want to see ‘clear and convincing’ evidence inflation is falling. But when you look at the historical record, growth matters too. Falling growth will help lower inflationary pressures.”
The Fed normally doesn’t pause until its target interest rate is in excess of annual inflation, UBS strategists led by Mish found after reviewing 11 times the Fed has paused a rate-normalization cycle since 1960. With inflation by the Fed’s favored measure at 6.6% over the past year, prices would need to fall rapidly to meet that condition.
With annual inflation elevated, the FOMC might focus on monthly changes, said Rishi Mishra, an analyst at Futures First. One pause scenario: Monthly consumer price figures of 0.3% or less from May to August, down from 1.2% in March, might reassure policy makers they are on the right path, he said.
“This brings down inflation expectations into a range where the Fed feels comfortable about de-anchoring risks,” Mishra said.
What Bloomberg Economics Says
“I see a pause possibly happening in December, not September. Since the April CPI report, I think the risks have tilted back to the more hawkish path. That’s because the services inflation is just too broad based and fast. You’ll need sizable deflation in the goods sectors to offset that and get inflation to where the Fed forecast it in March.”
--Anna Wong, Bloomberg chief US economist
A decline in the 10-year Treasury yield, which can be seen as a signal for inflation expectations over the next decade, could also contribute to Fed officials getting comfortable with the price outlook, said Steven Ricchiuto, Mizuho Securities chief US economist. The 10-year yield has declined nearly half a percentage point from a peak of 3.20% on May 9 in response to increasing concerns about a recession in the US.
While the Fed hopes to avoid a downturn, a slowdown will be necessary for a pause, said Ricchiuto, adding there are already corporate reports hinting at a slowing job market. Walmart Inc. and Target Corp. are among companies whose stocks have swooned in response to lower forecasts.
“They will react to a rising unemployment rate, especially if inflation is starting to come down,” Ricchiuto said. “You will start to see people coming into the labor force having more difficulty finding jobs. That is how it begins.”
Fed officials, for their part, have said they wouldn’t be upset by a small rise in unemployment from 3.6%, near a 50-year low, and Powell has described the job market as “tight to an unhealthy level.”
Because monetary policy works with a lag, the Fed might choose to pause with an incomplete picture of the outlook.
“The Fed is not exactly sure of where neutral is nor how much reductions in the Fed’s balance sheet may amplify rate hikes,” said Diane Swonk, chief economist at Grant Thornton LLP. “Add in the uncertainty about the world in which we live, and a pause at some point to reassess seems prudent. Policy works with a lag. The Fed wants to catch up but not outrun the market in its effort to tighten credit market conditions.”
Wall Street analysts started to lay out the conditions for a pause following Bostic’s comments to reporters Monday that “I have got a baseline view where for me I think a pause in September might make sense.”
Most economists and investors disagreed with that forecast, and some took issue at the remarks with inflation still near at 40-year high. Billionaire investor Bill Ackman tweeted that “inflation is out of control,” this is no time for a pause and “the Fed has already lost credibility.”
The pause talk comes after financial conditions tightened with a sharp selloff in stocks, giving some the impression it’s tied to markets.
“Changing tack on monetary policy because of financial asset volatility while inflation is still well above target would be a major, major threat to their credibility,” said Jefferies economist Thomas Simons. “If the labor market starts to really crack, then we might have a different story. But that hasn’t happened.”
Bostic, a policy centrist who doesn’t vote on rates this year, said his forecast is conditional on his outlook for slowing growth with inflation slowing by the fall. If that doesn’t happen, he says he might embrace continued aggressive hikes, or even larger increases.
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