Fed's Williams Keeps Door Open to Rate Hike

Jay Powell's Third in Command Says Inflation Still Too High

I am in what for me is Central Bank Heaven. I am attending a conference jointly sponsored by the Bretton Woods Committee and the Federal Reserve Bank of New York, where the event is being held: Exploring Innovations in Central Banking. All kinds of cool topics are being discussed by all kinds of smart people.

Cutting to the chase, NY Fed president John Williams kicked off the event, introduced by his predecessor and current BWC Chair Bill Dudley. In a week when several Fed officials have spoken and many media accounts have focused on the “ready to pause” and “get ready for rate cuts earlier than later next year” angle so the next step is to declare victory, I want to share what I took away from what the number three person at the Fed signaled on future rate moves.

First it’s important to note that when Fed officials speak at events like this they know that every word they say will be heard around the world and reacted to by investors. Their prepared remarks are written meticulously to make sure that what they intend to communicate comes across clearly.

Also, the President of the New York Fed is the number three in the chain of command at the Fed. Governors at the Board in Washington may be a little more willing and able to put their own policy spin on their remarks. Presidents at the regional Fed banks often take the liberty they have to go out on a limb and try to lead the rest of the FOMC (Federal Open Market Committee) in a different direction. But the NY Fed chief’s job is to drive home what the Fed chair is signaling and if anything illuminate, explain what is behind  it.

So what was Williams’  message today?

First, inflation has fallen from a 40-year high of just over 7 percent to 3%. “Nonetheless, inflation is still too high,” he says. Not exactly what you expect a Fed official ready to throw in the towel on another rate hike to say.

True, he says that inflation is declining and he expects it continue to fall to 2% by 2025. He uses his favorite image – and mine too now I might add – to explain the current dynamic: The Williams Inflation Onion Metaphor.

The first layer is global commodity prices which he sees coming down steadily. The second is the prices of goods - minus food and energy - which have seen a substantial and sustainable decline in his view.  The inner layer is the all-important prices of services, also minus food and energy, which are making downward progress as shelter costs gradually ease back as the rates on newly-signed leases decline.

So what about employment? He sees the once red-hot labor market cooling off and wages rising less quickly as more people come back to the labor force. He adds an important “but” here and it’s a big one (the emphasis added is mine of course):

“But there are limits to how much supply can increase, and some further reduction in demand is needed to fully return balance to the labor market.”

Note that he did not say this reduction in demand MAY be needed but that it IS needed.  This is an important caveat. Where will this come from if the most aggressive rate hikes in Fed history have not yet cooled off demand enough?  

 Williams is quite clear that Fed policy is firmly in restrictive territory and this is working now to bring supply and demand back into balance and get back to the Fed’s 2% target. He is clearly betting and hoping that his forecast will become reality over the next couple of years.  

Even so, he does again leave the Fed door open a crack to another rate hike towards the end of his speech when he says the key rate is “at, or near” the peak level of the fund rate. He acknowledges that the “future remains highly” uncertain. If the funds rate turns out to be only “near” its peak, then logically the only way for it get there is for the Fed to hike again. Again he seems to say, if we have to do more we will.   

What jumped out most for me from anything Williams said today is what he said to me when I asked him a question during the reporter “scrum” that immediately followed his prepared remarks.

I was asking him a question along the lines of what is the biggest risk for Fed policy now? Is it maintaining this hold, this pause on rate hikes and then finding out that inflation continues to rise, and more hikes are needed?

I framed this by saying, You said in your speech that policy is now sufficiently restrictive to bring down inflation – and before I could finish he jumped in to gently correct me. “I didn’t say policy was SUFFICIENTLY restrictive, I said it was RESTRICTIVE.”  He was correct and more importantly adamant.  He may expect inflation to come down but it’s clear he realizes that it may not. And this also seems to keep the door open to another rate hike until the data show definitively that inflation is truly under control.

I close with what Williams closed with as he brought his Inflation Onion back into the picture.

“Since I first started to unpeel the inflation onion a year ago, we have seen meaningful progress on bringing inflation down and restoring balance to the economy. But our work is not nearly done. I am committed to achieving our 2 percent longer-term inflation goal, creating a strong foundation for our economic future.”

Again, an important reminder from Jay Powell’s third in command that the inflation fight won’t be over till it’s over. And we are not there yet. A pause is not a declaration of victory and Williams is not letting us forget that.