Why Fed Governor, Michelle Bowman, is still hawkish on rates

9 Aug 2023 , 09:05 AM

The US policymakers live in a different orbit altogether. Despite the Fed fighting a long hard battle against inflation, and coming out relatively successful, the Fed governors continue to be predominantly hawkish on the policy front. In a recent speech made by the Fed governor Michelle Bowman, she underlined why she supported the Fed decision to hike rates by 25 bps in July. She also made it clear that her view on rates was still hawkish and the Fed believed that more rate hikes would be needed to bring down retail inflation on a sustainable basis. 

Key takeaways from Michelle Bowman’s speech

In her speech at the American Bankers Association Conference, Michelle Bowman laid out her perspective on the US economy as well as the likelihood of more rate hikes in the coming Fed policies. Here are some key takeaways.

1. According to Fed governor, Michell Bowman, the Fed would most likely have to hike interest rates further to bring down inflation in a meaningful and sustainable manner. She underlined that the rate hike in July may just be the start of more rate hikes by the Fed in order to fully rein in inflation. This comes at a time when the markets are pencilling in the possibility of the end of rate hikes and even Jerome Powell hinted that the Fed may use a prolonged pause as a part of its hawkish strategy.

    

2. Bowman feels that the July rate hike after the June pause was nothing surprising. June was not a shift but just a pause to allow the lag effect of rate hikes to get transmitted in the form of lower inflation. Bowman has underscored that inflation is high with the added fuel price risk now. In addition, consumer spending is extremely strong and there is a rebound in housing labour market; and both are indirectly feeding the higher levels of inflation. Bowman underlined that the 2% inflation target was totally sacrosanct.

    

3. However, Bowman also made it clear that there never was and never will be a preset course  for monetary policy. At the end of the day, it will be the data points that will drive monetary policy and nothing else. That only means that the Fed would be absolutely willing to raise the Fed Funds rates even higher if the incoming data indicated that progress on inflation had stalled. Traditionally, Bowman has been a lot more hawkish than her other colleagues, many of whom are now turning more dovish.

    

4. Bowman stuck to the Fed forecast that the US economy would close the year with Fed policy rate at 5.6%. That means, at least, one more 25 bps rate hike was on the cards, although it is not clear whether this would happen in September 2023 or after that. What is more intriguing is Bowman’s use of the “rate increases” (don’t miss the plural here) in her remarks. That means, Bowman wants to prepare the global markets for more than one rate hike this year with terminal rates closer to the 6% mark. 

    

5. In the July Policy, even while hiking the rates by 25 bps, Jerome Powell had sounded ambivalent. He had left the door open for another rate increase in September, but had also hinted that less aggressive data could mean that the Fed would extend the pause for a longer period this year. Needless to say, even Bowman has admitted that there has been perceptible progress on containing inflation with the consumer inflation coming down sharply from 9% levels to just about 3%. However, fuel could play the spoilsport.

    

6. Bowman clarified that she would now read too much into the latest fall in inflation rates to 3%, since it was just a single data point. What is important is whether inflation sustains at lower levels after the Fed stops hiking rates and after the lag effect of rate hike is exhausted. That is why, Bowman suggests not to relent in this battle against consumer inflation till the time it can be said with a degree of assurance that consumer prices are decisively down. That situation is apparently not what the Fed is seeing today. Normally, it is the last mile of inflation control that is the toughest part of the job.

    

7. Bowman also pointed to the two related factors of consumer spending and labour data. For instance, the Fed is currently keenly watching out for signs of slowing of consumer spending as well as signals that the labour market conditions are loosening. As of the latest monthly jobs data, hiring has slowed and that is good for inflation control. However, unemployment is low at 3.5% and there were still many more available jobs than there are workers to fill those jobs. That means, wages will continue to be high, demand for labourers will be high and inflation control will be less than effective.

    

8. According to Michelle Bowman, the missing chip in the whole piece is a fall in core inflation, in tandem with headline inflation. Core inflation is the inflation excluding food and fuel and hence it is less volatile However, core inflation has remained around 4.6%, which carries the risk that should the food and fuel situation turn for the worse, then headline inflation can really shoot up. The fall in core inflation has bene much slower than the fall in food inflation and fuel inflation. Core inflation an implicit target for Bowman and also for the Fed. Unless that falls sharply to around the 3% mark, the overall battle against inflation will continue to remain cyclical.

    

9. The Fed governor, Michelle Bowman, admitted that most banks had already tightened lending standards in response to higher interest rates and funding costs. As of now, there has not been any meaningful contraction in credit. That is because the banks have continued to increase lending to households and businesses. However, Bowman highlighted that any rate trajectory of the Fed would be independent of the tightening of credit. Like the unwinding of securities has been kept separately as a liquidity impact issue, even the tightness in bank credit would be kept as a separate subject.

    

10. However, Bowman concludes the stance of the Fed with a positive twist. As Bowman put it very eloquently, “The FOMC will make monetary policy decisions based on the incoming data and its implications for the economic outlook.” It is this use of the term implications for economic outlook that has given hope to market analysts. The bet is that, given a choice between inflation control and boosting growth, the Fed may not opt for the latter. After all, despite the tightness that is implicit in Fed policy at multiple levels, the one factor that is giving confidence to the Fed members is that GDP growth first estimate for the second quarter has been meaningfully higher at 2.4%.

There are two key takeaways. Firstly, the Fed still remain hawkish till the time the consumer inflation is decisively moving towards 2% mark. Secondly, growth engines will not be allowed to splutter and for that the Fed would be ready to tweak its monetary policy accordingly. For more updates, we have to wait for the September monetary policy announcement by the US Federal Reserve.