Richmond Federal Reserve President Tom Barkin isn’t ruling anything out in the realm of monetary policy.
Given a strong labor market, growth in gross domestic product, and seven months of cooling inflation data, Barkin says the U.S. economy could be on a path to a soft landing. But he also sees a potential risk that the deceleration in inflation could stall—or even reverse—before price growth falls to the Federal Reserve’s 2% annual target.
“It makes sense to be patient,” on the timing of interest-rate cuts in 2024, Barkin said Wednesday in an interview. “I could tell you a story of a healthy economy and softening inflation. But I could tell you a bunch of other stories, too.”
Regarding the financial markets’ expectations for rate cuts, Barkin said he isn’t worried that investors might have a different forecast from Fed officials. “If markets can work with you, that’s better than markets working against you, so it would be good for markets to understand our reaction function,” Barkin said.
Yet, in the six years he has been on the job at the Fed, he said, he’s had a lot of experience with the central bank’s forecasts differing from the markets’.
Barkin, like his colleagues at the Fed, wants to see a sustained period of cooling price growth. He said he would particularly like to see disinflation broadening beyond goods prices, which have been a significant driver of lessening price pressures in recent months. “It does make you worry about whether there is a head fake in those [goods] numbers in that you might see a rebound,” Barkin added.
Specifically, Barkin wants to see a deceleration of inflation in rents and services, where price growth has been sticky.
Economists have expected rent inflation to show signs of deceleration in measures such as the Consumer Price Index, but that hasn’t happened yet. “I’d just like to get more confidence that’s actually going to happen,” Barkin said.
There are also several areas that could lead to stronger inflationary pressure. A tight labor market is keeping wages up. The low supply of housing could create more pressure on rents and house prices. Globalization and geopolitics could put pressure on the price of goods. Manufacturers, price setters, could continue to raise prices. Nonetheless, Barkin said, “I do think we’re on the back end of that cycle,” no longer taking outsized price increases.
Barkin said he likes to look at the trimmed mean inflation rate, which he says measures a broader impact through the basket of goods. Currently, that measure is running at 3.3% for the past 12 months.
“If we see inflation continuing on its very nice, past-six-month run, and particularly if that starts to broaden through the inflationary basket, that’s the kind of signal that would [cause us to] say, now it’s time to start the process of normalizing rates,” Barkin said with regard to his outlook on the timing of interest-rate cuts.
He declined to provide a specific forecast when the Fed might cut rates, or how many times it might do so this year.
The January jobs report, which revealed the addition of 353,000 payroll positions and a rise in wages, pointed to a strong economy and further complicated the Fed’s calculus on rate cuts. But Barkin said it doesn’t change his views.
“I don’t know how much you can make out of one month,” he said, noting that the recent surge in wage growth is related, in part, to the weather in January.
But he also noted that job gains, which had been highly concentrated in sectors such as healthcare, government, and leisure and hospitality—had broadened out to other sectors in January.
“We’ll see what we get going forward, but it would be a positive sign for the economy if the job gains were broadening,” Barkin said, acknowledging that the report surprised him. “The employment story, which a month ago I would have told you seemed very clear to me, now seems less clear.”
Meanwhile, the lagged impact of 11 interest-rate hikes is still being felt through the economy. ”There’s a lag out there,” Barkin said, adding that he believes it takes 12 to 18 months for the economy to fully realize the effects of monetary policy.
Given that the Fed last hiked rates in July, the effects are still hitting some sectors. “In aggregate, the economy hasn’t gotten the full impact of those interest rates.” Barkin said.
Strong labor productivity, which some economists believe has helped keep economic growth on pace even as inflation slows, also isn’t something Barkin is taking too seriously at this point as an indicator of when to cut rates. He noted that the data have been volatile during the Covid-19 pandemic and that comparing 2019 data to the most recent productivity measure doesn’t show a “sea change in the performance of the economy.”
Artificial intelligence, automation, and robotics will help drive more productivity, Barkin said, particularly because he expects a tighter labor market. “But you can’t quite find it in the numbers yet,” he said.
The federal funds rate is currently restrictive, Barkin said, noting that can be seen in sectors like commercial real estate. “It definitely is having an impact in the interest-sensitive parts of the economy, but in the rest of the economy, it still feels to be somewhat on the come,” he said.
Commercial real estate, particularly downtown office space, is a “troubled sector,” Barkin acknowledged, especially in cities in his district, such as Washington, D.C., where employees haven’t returned to the office at scale.
“It’s not a new problem; real estate is a cyclical business,” he said. “The people in real estate understand that and the banks understand that.”
The Fed has conducted extensive stress tests of the nation’s largest banks, and Barkin said he doesn’t see anything that makes him fear that a crisis similar to the 2008 real estate crash is brewing.
But that’s another reason why he remains cautious. “Patience is warranted when you see very strong demand and inflation normalizing,” Barkin said. “You just want to test it.”
Write to Megan Leonhardt at megan.leonhardt@barrons.com
Read the full article here