The Federal Reserve should not rule out raising its policy interest rate by half of one percentage point on March 16, especially if incoming inflation and jobs data released before then show the economy is running “exceedingly hot,” said Fed Gov. Christopher Waller on Thursday.
The government will release two key inflation reports and a jobs report prior to the Fed meeting. The first of these key reports, the January reading of the Fed’s favorite inflation gauge — the personal consumption expenditure price index — will come early Friday morning.
“If…tomorrow’s PCE inflation report for January and jobs and CPI reports for February indicate that the economy is still running exceedingly hot, a strong case can be made for a 50-basis-point hike in March,” Waller said, in remarks to a conference on economic forecasting sponsored by the University of California, Santa Barbara.
“With the economy at full employment and inflation far above target, we should signal we are moving back to neutral at a fast pace, based on the performance of the economy, and a 50-basis-point hike would help do that,” he said.
Waller said that all Americans “should be alarmed” by the latest consumer price inflation data, which showed inflation running at a 7.5% annual rate in January, a 40-year high.
The Fed governor said he was “alarmed about the level of inflation and a bit uncertain about how the near-term may play out,” but hopeful that supply-chain bottlenecks and shortages will begin to ease after June, and that inflation — with some help from the Fed — will come down significantly by year’s end.
Given this outlook, Waller said he now supports increasing the Fed’s policy interest rate by 100 basis points by the middle of the year, up to a target range of 1% to 1.25%.
This could be accomplished with four quarter-point hikes at each of the Fed’s next four meetings, he said.
But “front-loading” a 50-basis-point hike may be useful to convey the Fed’s determination to address high inflation, he said.
Ukraine invasion’s effect on rate hikes
On Wednesday, traders lowered their expectations of a half-point hike on March 16, in the wake of Russia’s invasion of Ukraine. Some other Fed officials expressed more caution about such a large initial hike.
Waller said it is possible that the state of the world will be different in the wake of the Ukraine attack and “that may mean that a more modest tightening is appropriate.”
“But that remains to be seen,” and the uncertainty may last beyond the March 16 meeting, he added.
Waller said that the Ukraine situation did not obviate the need to raise rates next month.
“We need to take the first step in March,” he said, adding that the geopolitical situation would be a factor in the pace of further rate hikes.
Read: Ukraine invasion clouds forecast
Trimming the balance sheet
Waller also said he wanted the Fed to start to shrink its $9 trillion balance sheet no later than its July meeting.
Other Fed officials have not been as specific about the timing.
The Fed allows its balance sheet to shrink by letting maturing securities run off. During the last cycle, the Fed set monthly caps on the runoff that started small and then grew over time.
Waller said the caps can be larger in this cycle. At some point, the Fed will need to consider selling some of its mortgage-backed securities, but that is a decision for “down the road.” For now, Waller said only that the Fed shouldn’t cap the runoff of maturing MBS.
“These actions will get us into the second half of the year, when we will have six months of inflation data, and we can assess what the appropriate path will be for the rest of 2022,” Waller said.
If high inflation persists, Waller said he would mostly likely support continued hikes — and potentially at a faster pace.
Until recently, Waller was seen by Fed watchers as at the hawkish end of the spectrum of Fed officials.
But the doves on the Fed have shifted in his direction. Economists will be listening closely next Wednesday and Thursday when Fed Chairman Jerome Powell testifies to lawmakers to see where the center of the committee stands on interest-rate policy.