Written exclusively for InTouch Capital Markets
7th May 2018
By Steven K. Beckner
AMELIA ISLAND, FLA. – Though the Federal Open Market Committee left the federal funds rate unchanged last Wednesday, the Federal Reserve’s policymaking body signalled it will raise rates further this year, but Fed officials give no indication they want to move aggressively.
What’s more, they’re prepared to act flexibly. Atlanta Federal Reserve Bank President Raphael Bostic said Monday he doesn’t “have some preconceived notion” of how many times the FOMC should raise the funds rate as he spoke to me and a few colleagues at the Bank’s Financial Markets Conference.
Bostic, who voted for the March 21 rate hike, told us his base case is three 2018 rate hikes, but is “going to be data dependent” and could support two or four — or even one.
When I probed his rate predilections, he replied, “If developments happen that suggest the economy is weakening, I’m happy to stand pat too.”
Dallas Fed President Robert Kaplan outlined a similarly restrained perspective on monetary firming. After telling the conference the labor market is “tight and getting tighter,” he told us “wage pressures are building.” He said tariffs and oil prices are adding to inflation pressures this year.
Nevertheless, Kaplan said he can tolerate some overshooting of 2% in the context of a “symmetric” target.
“My base case for 2018 is three” rate hikes, Kaplan said. “In the medium-term should be moving toward neutral.”
The Fed “should be removing accommodation, doing it in a gradual way,” he continued, but various “structural headwinds” mean that “the path of rates and the shape of the path of rates should be flatter than we’re historically accustomed to.”
When they raised the funds rate to a 1.5-1.75% target range in March, Chairman Jerome Powell and Co. projected three total hikes, with some sentiment for four. But since May 2, officials have suggested it will take a lot to warrant a steeper path.
Ahead of last week’s meeting, the FOMC learned its favorite inflation gauge, the price index for personal consumption expenditures (PCE), had hit its target, rising 2% from a year earlier in March. But after the meeting, it was reported average hourly earnings grew more slowly in April, even as the unemployment rate fell to 3.9%. Earnings were up 2.6% from a year ago — a tenth less than in February and far below their pre-recession pace.
Although the “beige book” survey found skilled labor shortages, already low labor force participation fell further last month, suggesting side-lined labor could be curbing wage pressures. Or it may just be still stunted productivity is capping wages.
In any event, with wages not driving inflation sharply higher, the Fed seems apt to stay with the “patient” approach Powell enunciated in April.
The fact that inflation has finally hit 2% has pleased, not rattled, policymakers, judging from post-FOMC comments.
When I asked him about wage and price data, Bostic said “the PCE hitting 2% is a good thing,.. We’ve been trying to get there for the better part of six years… It’s encouraging to see that measure get to” target. But he’s not worried about an inflationary overheating, saying he is “comfortable with some degree of overshooting” of the 2% target. The Fed can’t tell “with a high degree of precision” where prices are headed, so “if it’s fluctuating around the 2% target, I’m comfortable with that.”
Bostic was disappointed with slowing wage growth, saying “we would have expected there to get some significant upward pressure on wages” given tightening labor markets. And he said that “if it continues the way it’s going, we’re going to see wages start going up, because we’ll have a scarcity of workers.”
When I asked about the implications of sluggish wages for overall inflation, Bostic emphasized, “We use PCE; that’s our baseline,” although “we take wages as an input” as to “whether markets are likely to be overheating.”
His comments are consistent with other comments since the meeting. New York Fed President William Dudley said Friday it would “not (be) a problem” for him if the PCE price index goes above target because it was below 2% “for so long.” San Francisco Fed chief John Williams, who will succeed Dudley next month, said he too would be “comfortable” if inflation overshoots and said “three or four” rate hikes this year is “the right way to think about it given the continued improvement in the economy.”
Williams said there could come a time in the next few years when funds rate needs to go above the longer run “neutral” rate, which the FOMC estimates at 2.9%, but only “slightly.”