Fed leaders back two more big rate hikes, but then what?

ATLANTA/ SAN FRANCISCO (Reuters) – U.S. central bankers broadly back two more big rate hikes in June and July, but what happens next is a matter of intense internal debate that revolves largely around differing views on how price pressures will play out in the coming months.

For Atlanta Fed President Raphael Bostic, once the Fed has made rate hikes of half a percentage point as outlined by Chairman Jerome Powell, “a pause in September could make sense.”

“I think a lot will depend on the dynamics on the ground that we’re starting to see,” both the inflation the Fed is trying to contain and the impact of higher interest rates on the economy, he told the Rotary Club of Atlanta on Monday.

While there is a risk that the central bank may have to be more aggressive, he said, “I’m optimistic and assume that inflation will have definitely started to come down” by then.

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Later, at another event, Kansas City Fed President Esther George painted a picture with more storm clouds, listing the many factors, such as Russia’s war in Ukraine and China’s COVID-19 confinements, that could intensify or alleviate inflationary pressures.

Added to this are the many ways in which the pandemic has changed the U.S. economy, resulting in a much tighter labor supply than previously estimated and a service economy that has struggled to regain capacity after massive cutbacks early in the crisis.

And he pointed to the “wild card” effect of an estimated trillion-dollar domestic savings glut that could make the Fed’s “task of cooling demand more difficult.”

Complicating matters, the Fed will begin shrinking its $9 trillion balance sheet next month, adding to the tightening of monetary policy against a market backdrop that is much more volatile now than the last time the Fed reduced its bond portfolio.

“The road ahead could be bumpy,” he said.

The Fed’s challenge is to tighten monetary policy enough to curb inflation, which has reached its highest level in 40 years, but not so much as to cause a recession in the economy.

Both policymakers acknowledged the difficult task ahead as concerns mount about a slowdown in global growth and the U.S. economy’s resistance to rising rates and falling stock values, among other adjustments.

Investors expect the Fed to keep raising rates throughout this year, putting the fed funds rate in a range of 2.75% to 3% by the end of the year.

Some of their colleagues have called for an aggressive push to put the policy rate at 3.5% by the end of the year, which would imply half-point hikes at all remaining Fed meetings.

Others say they expect the Fed to taper its rate hikes after July.

Bostic said he expects a shallower series of moves, with the Fed’s benchmark rate ending up in a range of 2 to 2.5% by the end of 2022.

The economy’s response to rising rates “is going to accelerate in the coming months,” Bostic said. “If we’re not on it, there’s a risk that we continue to move beyond the point where these markets have found equilibrium.”

George did not lay out a specific preference for rate hikes.

(Reporting by Howard Schneider and Ann Saphir; editing by Kim Coghill, translated by Jose Munoz in the Gda?sk newsroom)