(Reuters) -Two of the Federal Reserve’s most outspoken policy hawks on Friday pushed back on the view that the U.S. central bank has missed the boat on the fight against high inflation, citing a tightening of financial conditions that began well before the Fed began raising interest rates in March.
“How far behind the curve could we have possibly been in terms of time if, using forward guidance, one views rate hikes effectively beginning in September 2021?” Fed Governor Christopher Waller said, noting that the rise in yields on the two-year Treasury note that began last fall reflected the equivalent of two Fed rate hikes through December.
“What may appear as a policy error to some was viewed as appropriate policy by others based on their views regarding the health of the labor market,” Waller said at a conference at Stanford University titled “How monetary policy got behind the curve.”
St. Louis Fed President James Bullard, speaking at the same conference, took note of the rise in the yield on the two-year Treasury note, seen as a good market-based measure of the Fed’s policy interest rate.
The Fed raised the latter to a range of 0.75% to 1% earlier this week, a level that critics say is far too low to fight inflation running at three times the Fed’s 2% target.
Inflation is “far too high,” Bullard said Friday, and if inflation expectations rise further it would become very difficult to bring it down. But given that the two-year Treasury yield this week was around 2.7%, Bullard said, “We’re not as far behind the curve as you might have thought.”
Rates still need to rise, he said, noting that a widely used monetary policy rule suggests that rates need to be at least 3.6% to bring inflation under control. “We’re on the move, we’ve got more moves to make.”
Bullard and Wallard both said markets are getting that message. Traders of rate futures are currently pricing in a Fed funds rate of 3% to 3.25%.
The two were among the first Fed policy makers last year to call for a rapid removal of easy monetary policy and a quicker start to raising interest rates.
Bullard, in fact, dissented on the Fed’s March quarter-point rate hike as too little.
But both joined their colleagues in approving the half-point rate hike delivered this week. Fed Chair Jerome Powell, speaking after the rate decision was announced, signaled that two more such rate hikes through July would be likely.
Waller used his talk Friday to trace how economic data first seemed to ratify, then challenge, his own view from last spring: that inflation would prove transitory as supply chains healed and one-time fiscal stimulus faded, and that the labor market was primed to roar back as COVID-19 receded.
Most of his colleagues shared in the first view; opinions were more divided on the second. Waller believed the data showed the Fed would soon need to taper and end its bond purchases, a first step before raising interest rates, and he said so at the time.
In the end, Waller said, he was surprised that inflation proved to be much higher and more persistent than he had thought, a surprise that most of his colleagues say they shared.
He also described the “punch in the gut” he felt as two weaker-than-expected monthly jobs reports in August and September seemed to undercut the thesis of labor market healing.
As it turned out, later data revisions showed the U.S. labor market had been stronger than the real-time data suggested.
“If we knew then what we know now, I believe the (Fed) would have accelerated tapering and raised rates sooner,” Waller said. “But no one knew, and that’s the nature of making monetary policy in real time.”
By early November the data had become convincing to more and more Fed policymakers. Inflation was high and rising and wasn’t dropping on its own, and business demand for workers was far outpacing a slow-to-recover labor market supply.
“It was at this point… that the FOMC pivoted,” Waller said. The Federal Open Market Committee, known as the FOMC, s the Fed’s policy-setting body.
The conference featured several former Fed policymakers and economists who argued that the Fed had fallen so far behind the curve that it would almost surely end up causing a recession as it sought to catch up by raising rates faster.
Former Fed Vice Chair of Supervision Randal Quarles, who says he was the Fed’s most hawkish member until Waller joined late last year, told the conference that in hindsight it’s clear “it would have been better to start raising rates last September.”
It wasn’t a failure of nerve, or politics, or stupidity, he said Friday. “It was a complicated situation with little precedent, and people make mistakes.”
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