(Kitco News) – Cleveland Federal Reserve President and FOMC member Loretta Mester ruled out a rate cut at the May meeting on Tuesday, saying that the strength of the U.S. economy gives the central bank room to wait and that the balance of risk was weighted firmly toward inflation.
Speaking at an event at the Cleveland Fed, Mester said that the Fed has made “substantial progress” on inflation since it peaked in 2022, but it remains above the 2 percent target. “PCE inflation is now running about 2.5 percent, whether it is measured year-over-year or over the past six months, annualized, and core PCE inflation is running about 2.75 percent, measured year-over-year, and near 3 percent, annualized, over the past six months.”
She said the January and February readings were firmer than those of H2 2023 and called them “a good reminder of what we already knew: that the disinflation process will not be a smooth path back to 2 percent.”
Mester said that while she still believes that inflation will continue to fall over time, “I need to see more data to raise my confidence.”
“Some further monthly readings will give us a better sense of whether the disinflation process is stalling out or whether the start-of-the-year readings reflect a temporary detour on the downward path back to price stability,” she added. “I do not expect I will have enough information by the time of the FOMC’s next meeting to make that determination.”
While this would appear to rule out a May rate cut, markets had virtually ruled one out already, as the CME FedWatch tool showed only a 10% chance of a cut next month.
Mester acknowledged that the overall economy in the United States has performed above expectations. “A remarkable thing about the disinflation is that it has occurred in the midst of strong labor markets and economic growth,” she said. “While the broader tightening in financial conditions over time has led to some moderation in the growth of output and employment, both have remained stronger than expected.”
She warned, however, that with most of the COVID-era distortions now behind them, the remaining above-target inflation would be more challenging. “Now that pressures on supply chains are approaching normal and the labor market is coming into better balance, we are not likely to get as much help on inflation from the supply side as we saw last year,” she said.
Mester also raised her 2024 economic outlook, now predicting “it will grow a bit above my 2 percent estimate” of trend growth. “I expect the labor market to continue to come into better balance this year, with a slight uptick in the unemployment rate from its current very low level,” she said.
Addressing the interest rate path, she said that “if the economy evolves as expected, then in my view it will be appropriate for the FOMC to begin reducing the fed funds rate later this year.”
“These reductions should be viewed as a normalization of policy back to a neutral level as the economy returns to price stability and maximum employment,” she added. “But, of course, the actual path of policy will depend on how the economy actually evolves.”
Mester said her forecast for the Fed funds rate is in line with the median among the FOMC participants in the latest Summary of Economic Projections released after the March meeting, “except that I see somewhat higher inflation this year.”
She also broke ranks with Federal Reserve Chair Jerome Powell by directly addressing the long-speculated possibility that the nominal rate could be higher than it was previously.
“In my projection, I have also raised my estimate of the longer-run federal funds rate to 3 percent compared with 2.5 percent, which had been my estimate for some time,” she said. “I raised my estimate to reflect the continued resilience in the economy despite high nominal interest rates and higher model-based estimates of the equilibrium interest rate, r-star.”
Mester said that while her remarks reflected what she considered “the most likely scenario,” she saw several risks to the forecast, including “continued heightened geopolitical tensions, slow growth of the Chinese economy, potential deterioration in conditions in commercial real estate markets, renewed stresses in financial markets, and, on the upside, the possibility of stronger than expected productivity growth.”
Addressing the risks to monetary policy in particular, Mester said that the strength of the economy and the labor market has convinced her that the Fed should treat inflation as the greater threat. “At this point, I think the bigger risk would be to begin reducing the funds rate too early,” she said. “And with labor markets and economic growth both being very solid, we do not need to take that risk.”
She said the FOMC’s current monetary policy stance “puts us in a good position for managing risks that could manifest themselves on either side.”
“If the labor market deteriorates, we can move rates down sooner and more quickly than in our baseline,” she said. “On the other hand, if inflation appears to be stalling at a level above our goal, we can hold our restrictive stance for longer than in the baseline.”
Mester contrasted this with the situation when the Fed embarked on its tightening cycle. “[O]ur policy was not well positioned when we started our tightening cycle because the policy rate was so low and inflation was moving up persistently,” she said. We needed to raise rates fairly aggressively.” Now, she anticipates that the central bank “will be able to move rates down gradually as inflation and inflation expectations move down, allowing us to continue to manage the risks to both sides of our mandate.”
“[T]he actual path of policy will depend on how the economy actually evolves,” she concluded. “The FOMC’s job continues to be to assess the implications of economic and financial developments for the outlook and risks around the outlook and, given that assessment, to calibrate monetary policy so that inflation returns sustainably to our 2 percent goal and labor markets remain healthy.”
Spot gold appeared to take Mester’s hawkish comments in stride as it climbed back towards the new all-time high of $2,277 set at 10:30 am EST, last trading at $2,271.10 per ounce for a gain of 0.86% on the session.
