Stubbornly high inflation could prompt the Federal Reserve to take a more cautious stance this year on interest rate cuts, the former central bank vice president said Friday.
Richard Clarida, who served as Fed governor until January 2022 and is now a global economic adviser at asset management giant Pimco, said his former colleagues need to be wary of fixed rates that could thwart plans to ease monetary policy this year.
At its meeting earlier this week, the rate-setting Federal Open Market Committee indicated it was likely to cut interest rates three times this year, assuming quarter-point intervals. Bank President Jerome Powell said that falling inflation and a strong economy give policymakers room to cut.
“This may be more of a hope than a prediction,” Clarida said during an interview on CNBC's “Squawk Box.” “I hope the Fed does move into a data-driven mode, because there could be a very good case if inflation is flat and stubborn that they don't have to make three cuts this year.”
Markets are also anticipating three cuts this year, although that pricing has been scaled back after data from the start of the year showed inflation was higher than expected.
Fed officials believe high housing inflation is on its way down, paving the way for a reduction in the key borrowing rate from its highest level in more than 23 years. But Clarida said it's unclear how far the Fed can cut.
“Under a wide range of scenarios, they will get at least one cut this year,” he said.
However, the calculus is different as inflation data provide conflicting signals.
The Fed favors the Commerce Department's measure of personal consumption expenditures prices, with particular emphasis on the core reading that excludes food and energy. The headline 12-month PCE reading for January was 2.4% and the core reading was 2.8%, both above the Fed's 2% target but on track.
However, the most popular CPI in February was 3.2% headline and 3.8% core, both well above the central bank's target. Moreover, the Atlanta Fed's measure of “flat” inflation stood at 4.4% on a 12-month basis, and even higher, at 5% on a three-month annualized basis, the highest level since April 2023.
“If the Fed was targeting the CPI right now, we wouldn't even be discussing interest rate cuts,” Clarida said.
He also noted that although Powell said Wednesday that fiscal conditions are tight, they are actually “a lot easier than they were in November.” The Chicago Fed's gauge of financial conditions is at its lowest levels since January 2022.
“I think what's going on here is the delicate balance that (Powell) is trying to navigate,” Clarida said. “It's very natural that financial conditions will start to improve when they feel like the Fed is done and (will start) cutting interest rates. Then of course that improves the economic outlook and maybe makes it harder to get inflation down to 2” percent.
