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Fed’s strategy is ‘still banking on’ virtuous inflation decline, economist says

Dreyfus and Mellon Chief Economist and Macro Strategist Vincent Reinhart joins Yahoo Finance Live to discuss yesterday's FOMC meeting, inflation, supply chain constraints, oil and gas prices as the Russia-Ukraine war continues, and the outlook for the economy.

Video Transcript

JULIE HYMAN: So let's circle back to thing number one and dig into that a little bit more. And that is, of course, the Fed. Yesterday, among other things, Chair Powell sort of described the function by which raising interest rates will hopefully bring down inflation. Let's listen to what he said.

JEROME POWELL: As we raise interest rates, that should gradually slow down demand for the interest sensitive parts of the economy. And so what we would see is demand slowing down, but just enough so that it's better matched with supply. And that brings-- that will bring inflation down over time. That's our plan.

JULIE HYMAN: So let's talk more about all of this with Vincent Reinhart. He's chief economist at Dreyfus and Mellon. Vince, it's good to see you this morning. So we just heard Chair Powell sort of describe how, ideally, this will work. I think a big question in investors' minds is, will it work, A, and B, will it work without pushing the US economy into recession? What do you think?

VINCENT REINHART: Well, hope is always a strategy. And that's what we heard from Chair Powell. The thing you have to ask yourself is, is the Federal Reserve actually putting restraint on aggregate demand in the conventional way they think? In fact, in their forecast, the nominal federal funds rate is still well below their estimate of the neutral rate for this year and most of next year. And in real terms, it's actually negative for most of this year and next year. So it's not obvious that they're putting restraint on aggregate demand.

And by the way, they didn't change their forecast for the unemployment rate for this year or the next two. And while they marked down their forecast of GDP growth for this year, they didn't for the next two years. So it's sort of hard to see in the forecast they wrote down the mechanisms that Chair Powell talks about. The plain fact is the Fed is still banking that some of the decline in inflation in their forecast is just going to be virtuous. It happened. And that's the strategy. But you might not want to bet on it.

BRIAN SOZZI: Vince, you know this better than most that monetary policy works on a lag. Now the Fed really signaled strongly that it might increase rates six times this year. What impact will it have on the US consumer and the economy? Will things slow down sharply later this year?

VINCENT REINHART: Well, the reason they're raising rates gradually is so things don't slow down sharply. In terms of what does it mean to households, mortgages will be a little more expensive. You may see some increases in loan rates. It will harder to buy a car on credit. And so that-- the slowing that is in train.

The reason the Fed is going gradually is so there's not an abrupt change in the short-term rates that households care about for those credit decisions, and also they get feedback. If the economy slows more abruptly, they can put-- they can tap on the brakes a little less, or they could even pause. If, however, they're not getting the traction they expect on inflation, which is our forecast, they may actually have to extend the rate hike even further into 2024 than is in their forecast.

BRIAN SOZZI: And Vince, I think a lot of folks are trying to decode what the Fed meant when it said ongoing increases in rates. How do you interpret it?

VINCENT REINHART: This is the first of many to come. When the Fed moves, it moves gradually. Actually, monetary policy follows physical phenomena. It's Newton's law. A body in motion stays in motion. A body at rest stays at rest. The body was at rest from 2018. Now it's in motion. And there are going to be ongoing increases in rate.

JULIE HYMAN: Vince, I know you're not a commodity strategist, but I do wonder what your thoughts are on whether we have seen the peak in oil prices linked to the Russia-Ukraine conflict as a function of an input to inflation, right? Sort of by extension, have we or are we near peak in terms of inflation?

VINCENT REINHART: So the good thing about you asking me about oil prices and the progress of the Russian invasion of the Ukraine is, I'm not going to get it right, but nobody's going to get it right. There's a lot of uncertainty. With regard to the passthrough of higher oil price-- energy prices, generally, we haven't seen it all. And part of the resolve that Chair Powell showed at the press conference yesterday was to be in the right frame when CPI goes up even more. We could easily see CPI print as the previous-- the already happened increases in energy prices pass through next month, the month after that.

Remember, the Russian invasion was in the third week of February. February data doesn't really incorporate that. So don't be surprised if you read a headline CPI that starts with 9 on a 12-month basis. So now as for oil prices, generally, the world is a really risky place. And the invasion was an enormous shock to supply.

It's withdrawn not just energy, but grain and other commodities off the market and impaired already impaired supply chain. And so, you know, Chair Powell did note and he admitted that inflation hadn't come down as much as they thought. They had been banking on a quicker correction of supply chain problems-- hadn't happened. But also the invasion of the Ukraine has put further impetus in costs.

BRIAN SOZZI: Vince, 9% inflation, that is a big scary number. And I follow on that because you had Jim Bullard dissent here, making the case, again, for a 50 basis point rate hike. Is he going to be the lone wolf inside of the Fed, or he might have others start to join his camp?

VINCENT REINHART: Well, generally, dissents are not necessarily unhelpful. Chair Powell could point to the board's 50 basis points to saying, you know, my committee is pretty restive. Everything's on the table. We can go more forcefully if that's what's necessary. Generally, the FOMC is a pretty consensual place. And so if one person leans forward to say, I don't agree with the group, and I'm going to vote no, the other-- there might be another few people who would have done it first. But they wouldn't do it second or third. They wouldn't pile on, on their chair.

So I would believe that President Bullard's dissent is not unique among the FOMC. The point was noted. They didn't have to pile on. But if you get inflation running at 9%, if you get further upward revisions to the forecast, you're going to get a committee that's restive. And by the way, it's going to come from both directions. The dots you saw yesterday are not the dots you will see in September or December because there will be four members, maybe five new FOMC participants. And they will be more dovish than the current set of participants. So Chair Powell is going to be tugged in both directions.

JULIE HYMAN: This is a really important point, and I'm glad you made it. Vince, thank you so much for being here. Vincent Reinhart is chief economist at Dreyfus and Mellon. Thank you so much.