Fed Unlikely to Raise Rates in September

David J. Stockton says some central bank officials are still appropriately concerned about an inflation rate that has consistently fallen short of the Federal Reserve’s 2 percent target.
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Unedited Transcript

Pedro da Costa: I'm Pedro da Costa, Editorial Fellow here at the Peterson Institute for International Economics. I'm joined by David Stockton. He is a Senior Fellow here. And, we're looking ahead to next week's Fed meeting. And, until yesterday's speech from Fed Governor Brainard, the market pretty much was on the fence about a possible rate hike in September, but she seemed to be so dovish that everybody appears to have kind of gotten off the table. Where do you stand on that, Dave?

David Stockton: So, I see the prospects of a rate hike in September is relatively limited. I really have for quite some time now. Not that there isn't a debate that will likely take place at the leading. In case, it's good cases on both sides that could be placed but I just don't see at this point enough of a consensus on the committee to drive a further rate hike.

And the notion that Lael Brainard was going to go about and be the stalking horse for a September rate hike seemed quite improbably to begin with.

Pedro da Costa: What about as far as what you're seeing in the data? Do you think that the data do want an interest rate increase or do you also think that it's a close call in that sense?

David Stockton: So, I think it's a close call but I guess I would put myself more in the patient's camp in the following sense. Clearly, I think GDP is probably rebounding here in the second half of the year. We've seen some better data on consumption, less of a drag coming from inventories, the labor market is still advancing quite smartly. So, I think those are all positive signs.

On the other hand, really almost since the turn of year, core inflation has been stuck at around 1.5%. There's really no clear signs that's it's moving up yet. And I do think the case for patients and waiting just a bit longer is to make sure that in fact the Fed's expected return of 2% looks like it's actually underway.

Pedro da Costa: And, what will you be looking for let's say if the Fed doesn't raise rates, what will you be looking for in terms of future signals from both the language of the statement and potential changes in the forecast?

David Stockton: So, I do think the committee is inclined to continue this process of normalization. And while I don't think they'll do it at this meeting, I think their mission over the next few months if the data continue to come in relatively strong and if they see some modern science will pick up in inflation. They need to begin to get market expectations more aligned with the probability of a rate hike by the end of this year.

And, I would look for language that indicated that they were now last time they saw the risk as having diminished. This time, I would expect the language that might suggest the risks are relatively balanced. So there's sort of setting up the possibility that if data come in, the prospects for a rate hike would be reasonably high. So by the time they got to December, expectations would be much more closely aligned, 70%, probability or higher perhaps that they were going to actually move.

On the forecast, I think they are likely to have revise down growth this year given the weakness that they saw in the second quarter in particular. Even though we're seeing some rebound, I don't think it will be enough to offset that. But I'd really like to look at their economic side of their forecast, the output unemployment inflation to be largely unchanged from where it was.

Now, with respect to the dot plots, last time, the median expectation was for two hikes this year. If they don't go in September, I think we'll see the median shift down to 1%. That will actually be interesting. Obviously, if the median is below 1%, that will create some greater uncertainty that will it even move in December. But I'm expecting that we'll see something to suggest that a rate hike is still in the cards.

Pedro da Costa: Now of course, December is not the only meeting. There's also one in November. But everyone has pretty much discounted that one. And that's both, I guess, because there's not a press conference but we also have something else happening of course.

David Stockton: Yeah. So, I think despite the Fed's repeated statements at every meeting is live and to some extent, obviously, developments were to be so urgent that they needed to move, they could move off meeting in normal circumstances. There's no way that the Fed is going to undertake its second tightening days before a national election when you could trigger a market overreaction that could have effects on people perceptions of the economy that might not in fact be warranted. So, the Feds are going to keep their head down at that point and that's the wise thing to do.

Pedro da Costa: And then, what do you make of this pattern as far as Fed communications? We see repeated instances where regional Fed officials seem to talk up their [inaudible 00:04:43] over an interest rate hike and then the data seem to underwhelm, and then the Fed governors kind of walk it back. What is that dissonance and what do you make of it? Or is there any way to fix it or control it?

David Stockton: So, two things: one is there probably is a difference in some sense and policy. Inclinations between presidents and governors I think. Presidents traditionally have been more hawkish and governors more dovish. And I think we're seeing some of that as a reflection. But I think actually, what the symptoms that you're pointing out are really reflective of a deeper problem with Fed communications currently and that is there isn't really a strategy at the Fed for communicating with the public.

And by that, I don't mean a strategy for imposing a single point of view to be expressed to the public, but not a strategy that allows a balance of use to be expressed to the public. We have some bank presidents that really are in the public eye almost constantly. And, they wake up one morning and, "It looks like maybe two hikes will be good this year." And then they wake up a week later and say, "Well, I think maybe only one."

Whereas I think Governor Brainard's comments yesterday were sort of a good example of how to structure -- I thought that speech whether you're agreeing with it or not in terms of -- but she laid out very clearly what her thinking was about the course of monetary policy.

The Fed claims that they're data dependent and if the markets really believe that, the markets would be reacting to the data, not just every utterance of a bank president or a Fed governor. And, I think the Fed needs to think about developing a communication strategy that allows different points of view to be expressed but limits the amount of noise that gets thrown into the process by these constant -- not just the bank presidents versus the governors, but it's the bank presidents versus themselves in terms of shifting points of view quite frequently.

Pedro da Costa: Dave, thank you so much for your time. I appreciate it.

David Stockton: Pleasure.