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Interview

St. Louis Fed president favors 75 basis point rate hike

Jim Bullard sees inflation slowing in 2023, not in favor of raising by full 1%

St. Louis Federal Reserve Bank President James Bullard.    © Reuters

WASHINGTON -- St. Louis Federal Reserve president Jim Bullard says he will be in favor of raising the policy interest rate by 75 basis points at the Federal Open Market Committee (FOMC) to be held on July 26 and July 27.

The inflation rate for June in the U.S. surged by 9.1%, hitting a new 41-year high.

Bullard, in an interview with Nikkei on Wednesday, said that although inflation has not peaked, he expects it to slow down in 2023 -- and he does not support raising the policy interest rate by 100 basis points for now.

Edited excerpts of the interview follow.

Q: The June headline consumer price index in the U.S. rose 9.1% on a year-on-year basis. And the core rose 5.9%. And the labor market is also very tight. 

A: I think it sounds like the CPI report came in hotter than expected, although I just barely saw the numbers. But it sounds like both headline and core were higher than what financial markets were expecting. I think this ratifies the Fed strategy of moving expeditiously to neutral and beyond neutral, as we move through this year.

I think we've mapped out a strategy that will contain inflation and move us back toward 2%, but we do have to move quickly, and we are moving quickly, faster than our tightening cycle in 1994, which I think is appropriate, because we have a lot more inflation than we had in 1994, and so I think that this shows that the Fed's got the right strategy here for the funds rate.

Q: Is a 75 basis point rate hike appropriate, or do you have the option of a 100 basis point rate hike?

A: So far, we've framed this mostly as 50 versus 75 at this meeting. I think 75 has a lot of virtue to it, because the long run neutral that the committee has, according to the Summary of Economic Projections, is actually about 2.5%.

If we made this move at this meeting, that would get us all the way till the long run neutral value. And obviously we've got more steps to take in meetings ahead, but we can assess as we go through the rest of this year.

I've said it would be a good idea to get to 3.5% this year, and that would put downward pressure on inflation. A lot of that's already been priced into markets, so we've already got the market pricing that we need.

I think we're on a good pace, for now.

Q: Do you think there is a possibility of the federal fund rate exceeding 4% by the end of this year?

A: I suppose it's possible. I think that the 3.5% is already pretty aggressive. We're moving pretty quickly. And, like I say, a lot of the market pricing is already reflecting that.

If data came in, continued to come in, in an adverse way, for the committee, then we could consider doing more, as we go through the fall here. So, I'd say it's a possibility.

Q: Five of the 18 FOMC members in the June Summary of Economic Projections expected the policy rate to exceed 4% during 2023. One of the highest forecasts was 4.25% to 4.5%. Is a rate hike above 4.5% still not an option as the terminal rate?

A: I might have a little bit different view than others on the committee on this. I've advocated a front-loading strategy, so we would try to do as much as we can, as soon as we can, without being too disruptive to financial markets. And I realize there's a lot of readjustment of pricing in financial markets.

But, I think it makes sense, with the high inflation, to get the policy rate where you need it to be as soon as possible, and start putting downward pressure on inflation as soon as possible. And again, some of that's already been reflected in market pricing, so in some ways we've already got that in place.

I'm not really looking to do more in 2023, unless the data comes in, in such a way that it shows that we have to do more than we had previously expected.

But my expectation is that inflation will be declining in 2023, partly because supply constraints will be -- supply constraints will be fading at that point, but also because we will have adopted a tighter monetary policy, which will be putting downward pressure on inflation in 2023. I'm expecting that to be a year of declining inflation, and I'm hopeful that we'll do enough in 2022 that we'll get that disinflationary process going so that, in 2023, we don't have to do more.

I realize that others on the committee have different paths for the policy rate and maybe we will have to do more. But my basic idea is to front-load as much as possible in 2022, and get the disinflationary process going, and then we won't have to do as much, or anything maybe, in 2023.

We'll see. But a lot of this is very dependent on how the data comes in, let's say in the first half of 2023.

Q: Do you think inflation has peaked?

A: We've been looking for that for the last several months. It doesn't seem to have happened yet. I mean, one of the problems in 2022 has been that instead of fading, inflation has been broadening out to more and more goods and services, and to factors that are, tend to be more persistent, such as rents. Rent price inflation has been on the rise. And those things tend to take a while to turn around.

I'm not sure exactly when we're going to peak here. But I do think that we are going to start a disinflationary process soon, again, partly because the supply factors are going to fade and because the Fed has switched policies rather abruptly here and started to put downward pressure on inflation, and because the market pricing is already reflecting the tighter Fed policy, even ahead of the actual moves by the committee.

Q: The core inflation figure is stronger than we expected. So, there is a little bit of worry that the high prices will continue for a while.

A: I think this shows the fact that the Fed has been very aggressive during the second quarter here is warranted by this kind of data. We've done a lot of things to move to a tighter policy.

We've ended our balance sheet expansion and started to allow passive runoff of the balance sheet. That runoff is going to be about twice as fast as it was the last time that we did balance sheet runoff.

Then we raised the policy rate in March and in May and in June, and by increasing amounts at those three meetings, to the point where we made a 75 basis point move in June, that's the first one since 1994. And, as of today, I would advocate 75 basis points again at the next meeting, so that would be unprecedented that we've gone with that large a move in two consecutive meetings.

But I think that's all appropriate, because we have to get downward pressure on inflation very rapidly. And I think if we front-load our policy, this will put downward pressure on inflation, and we'll be able to contain inflation much more quickly than we were able to in the 1970s.

In the '70s, the inflation problem lingered on for 10 years and we had several recessions in the middle of the inflation problem. So, I think now we have more credibility, we're moving faster, we'll be able to bring inflation under control sooner and with less disruption to the economy than we had in the '70s.

Q: You mentioned that inflation is straining the Fed's credibility. Do you think the Fed could avert the credibility crisis?

A: I think we've moved very aggressively now in the second quarter here. The Chair [Jerome Powell] has said that our commitment to price stability is unconditional. Other members of the committee are very committed to getting inflation back down to 2%, and I think we're taking the right path of action to get that to happen.

Q: How do you analyze the possibility that the U.S. economy has already entered a recession?

A: I think the jobs numbers, the nonfarm payroll growth, has been very, very strong in the first quarter and the second quarter, and I don't think those numbers are consistent with any kind of interpretation that the U.S. is in recession.

I've never seen a recession where you created 2.7 million jobs in a six-month period.

I think, and anecdotal reports from businesses seem to indicate, that business is quite strong and demand is quite strong.

Businesses do have complaints, but their complaints are not about the amount of demand in the economy. They'll talk about supply issues and they'll talk about input costs going up, and they'll talk about the difficulty in finding workers, which is still extraordinary. There are still very close to two job openings for every unemployed worker in the U.S., so I think labor shortage is the predominant concern of most companies that I talk to, both in the Eighth District and across the country. These kinds of things don't sound like a recession.

I do think there is an issue with GDP. GDP growth was negative in the first quarter and some tracking estimates have negative GDP growth in the second quarter. But there, I think, this might be an opportunity to look at the twin of GDP, which is the gross domestic income measure of national income. That is supposed to be the same as the GDP, the gross domestic product number, and it's not, because of statistical issues.

But the gross domestic income number was positive, growth was positive in the first quarter, and we'll see what it is in the second quarter. So, I think this might be an instance where the gross domestic income number is telling us more about what's going on in the U.S. economy than the gross domestic product number.

There are also special factors that seem to be associated with net exports and change in inventories which seem to be very unusual. So, I think, my interpretation, I take GDP very seriously. But my interpretation is that here it's not telling us the right story about the U.S. economy.

The economy is continuing to expand in the first half of 2022, and it is slowing from the pace at which we grew in 2021, but I think it's slowing to the trend pace of growth, which is about 2%, and it's not slowing to a recessionary level, the way the GDP numbers would seem to indicate.

Q: Emerging economies are also rapidly raising interest rates to defend their currencies and curb inflation. And the global debt level is very high. Is there any risk that tightening of monetary policy could lead to a new financial crisis?

A: On this issue, I think I would commend many foreign central banks for taking preemptive action ahead of the Federal Reserve, in anticipation of tighter policy in the U.S., and I think that that has mitigated some of the concerns that might have otherwise occurred, about the effects of U.S. policy on foreign economies, especially emerging market economies.

And I would credit the idea that we've been more transparent than we maybe were in decades past about the direction of policy, and that global markets were better prepared for the change in policy that occurred in the U.S., and I think that's helping us to avoid surprises that otherwise might have occurred, if we had moved abruptly without the transparency.

So far, I think, you know, I have been pleased with that part.

Having said that, I understand that any time you're moving this quickly with U.S. monetary policy, it's going to mean that financial markets have to reprice tens of trillions of dollars of assets globally, which is not the easiest thing to do, and so you're going to see a lot more financial market volatility than you would otherwise see, and that has certainly occurred, and we're certainly seeing a lot of that. But that repricing has to go on, in conjunction with the anti-inflationary policy in the U.S.

Q: How do you see the slowing China economy?

A: I think the issue in China remains COVID, which I think is becoming less of an issue in Europe and the U.S. and other places in the world. But the Chinese policy of trying to sharply contain COVID-19 through the so-called zero-COVID policy does lead to shutdowns and inconsistency in production. Some have estimated a sharp slowdown in second quarter production in China.

I think that Chinese authorities have to decide what they want to do.

We do have effective vaccines that could be deployed, that would mitigate this problem to some extent. I'm not sure that they want to do that.

I think we're going to see continued volatility from the Chinese economy this year, and that's going to mean less global growth than we'd otherwise have, and so that will be a slowing growth, global growth, story. You're seeing that, certainly, from IMF estimates and elsewhere.

However, from the point of view of containing inflation in the U.S., that's not all a bad story. I think, you know, somewhat slower growth, more like trend growth, in the U.S., would be more consistent with our 2% inflation target. And so, to the extent that's happening, that's good news.

Q: The U.S. dollar is surging and now has even reached parity with the euro for the first time in 20 years. 

A: I guess my general interpretation is that the U.S. seems to have more inflation than some other jurisdictions. At least, core inflation seems to be higher in the U.S. than other jurisdictions, especially Europe. European core inflation seems to be lower. Overall inflation in Europe is just as high as the U.S., or higher. So, they're more sensitive to energy and food prices than the U.S. is.

What this is doing is rationalizing a tighter and more aggressive policy in the U.S. and a somewhat lagging policy in Europe compared to the U.S. They are going to raise rates but it looks like not as fast, or as soon as, the U.S.

That sounds like a stronger dollar. Also, the U.S.-BOJ, the dollar-yen, you have reported for years that the BOJ has had a hard time hitting its 2% inflation target, and it is one of the few spots in the world where inflation isn't nearly as high.

I think the idea of the BOJ is to lag the rest of the world in fighting inflation so that they can import some of the inflation and hit their 2% target. And that seems very reasonable.

Now, how much of that would be too much I think is a great question. But these two considerations make it sound like, well, the U.S. has a very aggressive policy and Europe and Japan are going to lag behind as far as the aggressiveness of their policies, and that sounds like a stronger dollar. That's exactly what's happening.

You've got the yen-dollar at I guess approaching 135 to 140, and you've got the dollar-euro approaching parity. These are not surprising developments, to me, but they do have ramifications, of course, around the world.

And again, I think markets have to reprice, based on these major moves in exchange rates.

Q: In the past, some rate hikes were done as a surprise. Do you think that's the way it should be? 

A: I think it's good to compare the Volcker disinflation in the early '80s, the Greenspan tightening cycle in 1994-95, and the current cycle.

The Volcker era had very high inflation, but low credibility for the Federal Reserve. Markets, global markets and U.S. markets, did not believe that the Federal Reserve was serious about getting inflation lower, and because of that Volcker really had to fight for credibility every day and had to prove to markets that he was serious, and you ended up with a very, very high policy rate and a very big recession.

I don't think we're in that situation today. We have much more credibility than Volcker had, and we are taking the appropriate actions to bring inflation under control. So I think it's going to -- you know, I'm hoping, and I do believe, it will be a smoother process than what we saw in the Volcker era.

Now, in '94, Greenspan had more credibility than Volcker and did not have that much inflation in the U.S. economy. However, inflation really wasn't all the way down to 2% at that time. He moved very aggressively in 1994, 300 basis points in about a year, and managed to cement inflation expectations at 2%, and really established an implicit 2% inflation target for the U.S.

I think that that's a better model for what we're doing today, even though we have higher inflation. We're probably going to have to do more than Greenspan did in the '94-'95 episode, because we do have more inflation. But we also have more credibility than he had.

I think we're going to have to move more than, probably, 300 basis points, in total. But because we have more credibility, a lot of this has already been reflected in market pricing and continues to be reflected in market pricing, and this is helping us to bring inflation under control.

Even though today's inflation report was high, I think this just shows that we have the right policy, move fast, move aggressively, front load the policy, and then we'll see declining inflation later this year and in 2023.

Q: Based on June inflation rate, do you think the expected inflation rate will rise further?

A: I haven't seen the TIPS (Treasury Inflation-Protected Securities) market reaction to this, but I have been encouraged over the last 30 days or so, where TIPS-based inflation compensation has moved back below 3% for the five-year horizon and for the five-year, five-year forward horizon. And I would take that as an indication that markets feel that, in the medium term and the longer term, inflation will come under control. And I think that's good news for our inflation control program.

[Wednesday's] report may -- this was a hot report, so maybe you'll get some repricing there -- but again, I think this just ratifies the idea that the Fed has the right policy.

Q: There is an argument that the nominal neutral interest rate is rising. What is your thought on that?

A: I think the neutral rate idea has two components. One is the long run neutral rate, if inflation was at 2%. And according to the committee that's 2.5% according to the median SEP projection.

So, we kind of have a number for that. I don't know if that's anybody's actual long run neutral. But that's the median of the committee. So that gives you, kind of, a ballpark for that number.

And then, of course, we don't have 2% inflation; we have much higher inflation. So then, to get to some idea of where the policy rate should be, taking into account that inflation is not at 2%, that, I think, comes from Taylor-rule type calculations, and the Taylor-rule type calculations tend to say we should be much higher on the policy rate than we are now. But, we're moving quickly.

I gave a talk at Stanford, maybe six or eight weeks ago, that did some calculations about a Taylor rule, and where I thought we needed to get, and I think the minimum is about 3.5%, and then we'd have to make judgments from there whether we have to go further, depending on how the data come in.

Q: Are you confident of a successful soft landing?

A: Yes, I'm hopeful that we can get a soft landing, as we did in '94-'95, and get inflation back on track toward, or at, 2%, and be on the balanced growth path. That's what happened in the second half of the '90s. It set up the economy for one of the best periods of growth that we've had in the postwar era.

I am hopeful that we can do that. I'm encouraged that the labor markets have continued to be exceptionally strong in the first half of 2022, even as we made our hawkish pivot.

Of course, I'll watch the data very carefully here. I think the GDP is sending a kind of false signal here, and so I would go by the jobs numbers as an indicator that the economy remains robust at this point. It will slow, but it will slow to the trend pace of growth and inflation will come down, and that would be the soft landing that we're looking for.

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