Governor Speak: Michelle Bowman bets on more policy tightening

28 Sep 2023 , 12:39 PM

She has been consistently underlining the importance of maintaining a hawkish monetary policy, till the inflation and the inflation expectations were reined in. Bowman has also, in the past, maintained the stand that high rates could be a reality for much longer than originally anticipated. That is largely because the inflation monster could take longer to be tamed this time around, due to a mix of cyclical and structural factors.

In the Fed communications, which Jerome Powell takes very seriously, the broad focus has been to give a transparent picture to the market and also to stick to their pronouncements. Here the pronouncements not only include the Fed statement and the Fed minutes, but also the speeches and talks given by various governors of the Fed, who constitute the members of the FOMC. It is in this light that the speech delivered by Michelle Bowman at the Community Bankers Forum assumes importance. Here are some of the key takeaways from the speech made by Fed governor, Michelle Bowman.

Why Bowman sees reasons to be hawkish on rates?

Here are some key takeaways from the speech delivered by Michelle Bowman, which underlines the need to maintain a hawkish stance for much longer.

1. At the September meeting of the Fed, the members had voted to maintain the Fed rates in the range of 5.25% to 5.50%. This pause in September came after the Fed had already raised rates by 525 points since March 2022. Effectively, the rates had been hiked from a range of 0.00% to 0.25% to the range of 5.25% to 5.50%. However, Bowman underlined that the pause was just to evaluate the progress on inflation and was not meant to be interpreted as the end of rate hikes in the US. 

    

2. Bowman underlined that in this period since the rate hikes had started, the Fed had seen a very meaningful impact on inflation with the rate of inflation coming down from a high of 9.2% to as low as 3% in June, before bouncing to 3.2% in July and further to 3.7% in August 2023. The best that the inflation figures warrant is a pause in rate hikes rather than an end to rate hikes. Also, going ahead, the rate hikes, as and when they happen, would be gradual and more calibrated.

    

3. However, Bowman has also used the forum to underline that consumer inflation was still too high compared to the inflation target of the Fed. The Fed had set a target of 2% for inflation, but after touching 3%, the inflation had bounced back to 3.7%. Effectively, the rate of inflation now is 170 bps away from the target inflation and hence talking about the end of rate hikes would be too premature, according to Bowman. According to Bowman, it would be appropriate for the Federal Open Markets Committee (FOMC) to raise rates further and hold them at a restrictive level for some time. That would be essential to bring inflation towards the 2% goal in a phased manner.

    

4. In her speech, Michelle Bowman spoke about the persistent risk of fuel inflation in the overall calculations. In the August inflation reading, the food inflation and even the core inflation had actually tapered over the previous month. However, the negative fuel inflation had narrowed sharply, showing pressure coming from fuel prices. There are two points here. Firstly, with Brent at $93/bbl and WTI (West Texas Intermediates) at $90/bbl, there is likely to be a rush for $100/bbl oil price. Secondly, fuel inflation has strong externalities (spillover effects). Hence, the high fuel prices would, most likely, seep into food inflation and core inflation in the coming months.

    

5. According to Bowman, there could be two triggers for slowing on rate hikes. The first trigger would be if inflation is under control, in which case, the Fed could go easy on rate hikes. However, that is not the case as inflation continues to play truant. Secondly, there is a case for going slow on rate hikes if the growth engine is being  negatively impacted. The impact on the growth engine can be seen through the lens of GDP growth or from the lens of consumer spending. Bowman has rightly pointed out that, on both counts, the US economy was doing much better than expected. Here is how.

    

6. Let us look at the real GDP growth first. Despite the second estimate of Q2 GDP being downsized to 2.1%, the overall growth is still much better than expected. In the latest projections provided by the FOMC members. The rate of GDP growth for 2023 has been upped from 1% to 2.1%. That is robust growth. The second area of focus is consumer spending and that is a direct corollary of the labour market. Consumer spending has been robust, and the housing sector appears to be rebounding. The most recent employment report showed a labour market with solid job gains. The unemployment is expected to stay under 4% and that is as close to full employment as can be. Let us now look at the link between the labour market and inflation.

    

7. Most US economists have opined that the one reason the inflation in the US has not come down, despite rates being at 22 year highs, is the labour market. The demand for labour continues to be far in excess of supply of labour and that has kept wages at higher levels. Now, higher wages have partially absorbed the impact of higher inflation and as a result, the consumer spending has not been overtly impacted by the higher rates. That is one major reason why the inflation has remained high, despite the Fed raising rates. According to Bowman, with such sold data flows from GDP and labour market, there is no real justification for monetary looseness.

    

8. According to Michelle Bowman, after the banking crisis in early 2023, there were concerns that banks would tighten credit lines and impact consumer spending. However, that is not how the story has played out. Overall banks continue to be resilient, with only some select mid-sized banks having been impacted. While banks have tightened lending standards, it has not resulted in any meaningful contraction in credit. Here again, the household balance sheets have been strong even as bank balance sheets have been tepid. That has offset the risks. 

It is clear that Bowman is tilting towards more hawkishness; not only as an option but also as a desirable option.

How Bowman sees rates panning in future?

Michelle Bowman has been a long time votary of a data driven approach to rate setting. According to Bowman, with the mixed data releases (strong spending data but a decline in inflation and downward revisions to jobs created), the Fed is justified in keeping its hawkish options open. That is the way it should be. While the Fed statement has not been too categorical about future rate hikes, Bowman is of the view that further rate hikes will likely be needed to return inflation to 2% in a calibrated manner. For instance, the Summary of Economic Projections released with the September FOMC statement, showed that median inflation expectations are above 2%, even till the end of 2025. That is a signal that the Fed may have to continue to play an active role in keeping inflation in check. 

That leaves the big question of how the Fed will use the Fed Rates as an instrument in the future. For now, the Fed statement has spoken about one rate hike in November, but not much beyond that. Bowman feels that the Fed should and would remain willing to raise the federal funds rate at a future meeting if the incoming data indicates that progress on inflation has stalled or is too slow to bring inflation to 2% within a specified time frame. The real question for the Fed from a macro stand point would be “How much is too much.” For now, there are no easy answers!