Fed Just Getting Started With Rate Hikes, Mester Says, Acknowledges Recession Risk

Cleveland Federal Reserve Bank President Loretta Mester speaks in London, UK, on July 2, 2019. REUTERS/Marc Jones/File Photo

The U.S. central bank is “just at the beginning” of its monetary tightening cycle and Americans should brace for interest rates to go higher as the Fed battles soaring inflation, Cleveland Fed President Loretta Mester said, while acknowledging the risk of a recession.

Mester, who is a voting member of the Federal Open Market Committee (FOMC), told CNBC in an interview that aired Wednesday that, in order to quell inflationary pressures, the Fed will have to keep hiking rates quickly to between 3 percent and 3.5 percent—and possibly higher if economic conditions warrant.

“It’s really important that we do that, and do it expeditiously and do it consistently as we go forward, so it’s after that point where I think there is more uncertainty about how far we’ll need to go in order to rein in inflation,” Mester said.

‘A Little Bit Higher Into Restrictive Territory’

In order to quell stubbornly high inflationary pressures, she said the Fed might have to err on the side of tighter financial conditions.

“We’re on a path now to bring our interest rates up to a more normal level and then probably a little bit higher into restrictive territory,” she told the outlet.

The FOMC at its June meeting voted to raise rates by 0.75 of a percentage point, the sharpest single boost since 1994, putting the target Federal Funds rate at between 1.5 percent and 1.75 percent.

Stubbornly high inflation has investors betting that, when the FOMC meets again at the end of July, they'll hike by another 75 basis points. Federal Funds rate futures contracts, as per the CME FedWatch Tool, put the odds of that size of a hike at 86.7 percent.

‘There Are Risks of Recession’

After being behind the curve of the current inflationary wave, the Fed has moved aggressively to tighten monetary conditions, fueling fears of a recession.

Fed Chair Jerome Powell said recently that the Fed’s commitment to bringing down inflation was “unconditional” while acknowledging that the fight against soaring prices could push up unemployment.

Some analysts believe the U.S. economy has already tipped into a contraction, with the latest Atlanta Fed real-time GDP projection estimating that second-quarter growth stands at 0.3 percent, up from a reading of 0.0 percent a week prior. The economy contracted 1.5 percent in the first quarter, with a recession generally defined as two consecutive quarters of negative growth.

While Mester acknowledged in the interview that “there are risks of recession,” she said it’s not her baseline forecast for the U.S. economy, just for “growth to be slower this year.”

Expecting a slowdown but not an outright recession is also the view expressed by New York Fed President John Williams in a separate interview on CNBC on Tuesday.

“A recession is not my base case right now,” Williams told the outlet. “I think the economy is strong. Clearly financial conditions have tightened and I’m expecting growth to slow this year quite a bit relative to what we had last year.”

Mester said she expects GDP growth this year to come in below 2 percent, while Williams’ estimate put the figure at between 1 percent and 1.5 percent.

“But that’s not a recession,” Williams said. “It’s a slowdown that we need to see in the economy to really reduce the inflationary pressures that we have and bring inflation down.”

Billionaire investor and hedge fund manager Bill Ackman echoed Mester’s view that the Fed needs to be unwavering in its tightening cycle.

“Business is a confidence game. Consumer confidence is weak because of inflation, not because of the economy. Jobs are plentiful and the economy is strong. The@federalreserve needs to act decisively to kill inflation and inflationary expectations. Then confidence can be restored,” he wrote in a tweet Wednesday.

Mester said she expects what she described as a “bumpy ride” toward tighter financial conditions would drive up the unemployment rate from the current 3.6 percent to between 4 percent and 4.25 percent over the next two years.