Philadelphia Fed President Patrick Harker speaks with Yahoo Finance [Transcript]

Patrick Harker, President of the Federal Reserve Bank of Philadelphia, joined Yahoo Finance Live on June 22, 2022, to discuss his economic outlook and the Fed’s recent decision to raise interest rates by 0.75%.

BRIAN CHEUNG: President Harker. Good morning. How are you?

PATRICK HARKER: Good morning, Brian. Thanks for having me.

BRIAN CHEUNG: So a lot to talk about, obviously the big news headline coming from the Fed last week of that 0.75%, 75 basis point, move. It was an interesting kind of whiplash from the beginning of the week, or the later parts of the week before that, when we had expected a half a percentage point move from the Fed. Walk us through exactly how that pivot happened, why the Fed decided to get more aggressive in last Wednesday’s decision.

PATRICK HARKER: So obviously, I can just speak for myself and my own decision making on that issue. So start with where I think we need to go. I think we have to put this in a broader perspective. I think we need to get to neutral. My estimate of neutral IS two and a half percent. Quickly. But we don’t have to overdo it. We don’t have to rush too quickly, but we need to get there soon. And then end the year above neutral, and somewhere above 3%. In a restrictive stance of policy to start to bring and continue to bring demand down. So in terms of the 75 basis point increase, that helps us get to that neutral stance and we’ll see how the data evolve over the next couple of weeks, next couple of months, to see how much more we need to do and when we need to do it. I know where we want to go, which is above 3% by year end, we’ll just let the data dictate how we get there.

BRIAN CHEUNG: So on that point, there’s four more meetings for the rest of this year. Fed Chair Jay Powell laid out pretty clearly that the decision for at least the next meeting at the end of July is between 50 basis points and 75 basis points. What do you kind of lean on that right now?

PATRICK HARKER: Again, I’m not ready to make a final decision there. But it’s exactly where I am: between 50 and 75. If we start to see demand soften, and we are seeing some signs that demand is starting to soften in certain sectors of the economy. And if it’s softening quicker than I anticipate, then it may be appropriate to go with a 50. If it’s not, then it’s probably appropriate to go with the 75. Let’s see how the data turns out in the next few weeks.

BRIAN CHEUNG: How difficult is the guidance right now? I mean, I guess the last minute pivot in the last meeting kind of underscored just how difficult it is for the Fed to maybe say we’re going to do 50 basis points in the next two meetings, but then have the data come in in a little bit of a different story. So how do you think about that? Does it maybe affect Fed credibility, the type of pivot that we saw last week?

PATRICK HARKER: No, I don’t think so. Again, I think we’ve been very clear that we need to move to a restrictive stance. How we get there is dependent on the data. So we can’t be that precise, what we’re going to be doing in September or December right now. I mean, the data will dictate that.

BRIAN CHEUNG: So I guess the larger question for Americans that maybe aren’t dialed into Fed policy on a day-to-day basis is: when do these rate hikes start to bite into inflation? When do you expect to see numbers start going down in the CPI or the PCE?

PATRICK HARKER: Hopefully sooner rather than later. That is the goal. Because we know the pain this is causing the American public. We are again starting to see some signs of demand softening, which is exactly what we want. We don’t want it to crash and we want to bring the economy into a safe position and in balance with supply and demand. So I think we’re starting to see some signs that demand is softening. And when will inflation start to come down? Our estimate? Our best estimate right now is next year it will still be high, or could be north of 5%. But then easing into around two, two and a half percent in the year after that.

BRIAN CHEUNG: When you see the demand softening, does that imply that maybe at least from your viewpoint that inflation could be close to peaking already? I mean, I don’t want to read too much into just one report but your own Philadelphia Fed manufacturing business outlook survey certainly suggested that you’re starting to see future general activity, new orders, shipment indexes fall sharply.

PATRICK HARKER: Yes. So it could — and I emphasize could. This is where we just need to see how things evolve in the next few weeks.

BRIAN CHEUNG: So I want to read to you I guess an excerpt from your former colleague in New York, Bill Dudley, who had an op-ed this morning saying, “if you have hopes about a soft landing, abandon it. A recession is inevitable within the next 12 to 18 months.” Just wondering how you might respond to those comments.

PATRICK HARKER: Yeah, so we could have a couple of negative quarters, but I think the situation we’re in right now is — and this word is overused, “unprecedented.” But I really think it’s unprecedented. We came into this pandemic with a very tight labor market and a very strong economy. We still have very tight labor markets. So the historical examples that you would rely on in this situation don’t quite fit. This is unique, but I think we have to recognize that and execute policy based on what we’re seeing, not based on some historical example.

BRIAN CHEUNG: Yeah. And as you mentioned, I guess maybe two quarters of negative GDP might be more of a feature instead of a bug of the Fed rate hikes. So in your view, what is the hard landing? What would make for a hard landing that would be experienced by Americans and households.

PATRICK HARKER: I think if we saw unemployment rise significantly above at least my natural rate estimate of around 4%. If we saw — and I don’t see that. I’ll give you one example. I was talking to a CEO of a multinational manufacturing firm yesterday, and he brought up the issue of keeping his employees. He said, you know, I worked really hard to get these employees around the world. To retain them, to attract them. And I’m not going to let them go very easily. So I can ride through whatever bumps we have in terms of the economy, but I’m not going to let my employees go so easily. I think that sentiment is out there more broadly in the economy, because people know they had to really struggle to get those employees and hold on to them. So I don’t see us seeing a rapid increase — at least my forecast right now — is a rapid increase in unemployment, given that psychology that’s in the market.

BRIAN CHEUNG: Yeah. And as you mentioned, I mean the labor market in a good position right now. 3.6% unemployment rate as of the last read, but you have some questioning the ability of the Fed, especially now with its more aggressive stance, to preserve the health of the labor market. Larry Summers, former US Treasury Secretary, saying that it might take five years of above 5% unemployment to take inflation down. I imagine that would be a so called hard landing. Do you think job loss is going to have to happen to cool this economy?

PATRICK HARKER: Well, first, let’s start with all the vacancies we have. So yes, we’re not going to fill those vacancies. People aren’t filling them right now, obviously because they’re vacancies. So we might see some pullback on just the job postings first. And we’re starting to see a little of that, but not a lot. So everything I hear is that the labor markets were tight, they’re gonna remain tight. And some of this is driven by longer term issues that are outside of economics. It’s demographics. We, the boomers, are retiring. Some may come back right now, but I don’t know long-term. We’re going to retire. We’re not replacing the boomers, whether it’s with immigration, or with the birth rate in this country, quickly enough. So we’ve going to continue, in my view, to have tight labor markets.

BRIAN CHEUNG: So I want to get back to the story of inflation because obviously oil and gas remains the most visible part of the inflation to average Americans. I’m sure you see it as well, driving around South Jersey. But people might be wondering, what’s the Fed going to do? I mean, how do rate hikes impact the supply of oil? It doesn’t, right? So how does that kind of fold into your thinking on what is the appropriate policy when you have these supply chain issues, still very much part of the story.

PATRICK HARKER: So this is why I look at not just a headline number or a core number, but how diffused is inflation across all the goods and services in the economy? How many are experiencing above 4%, say, inflation or above 5% inflation? If we start to see the number of goods and services, the actual number shrink in terms of those who are seeing those large inflation numbers, that gives me some hope. Because again, it’s not just a headline number, you’re right. Numbers like energy, food, these are affected by the tragedy we’re seeing in Ukraine, global economic conditions. We have to look through that to the underlying data in order to drive policy.

BRIAN CHEUNG: How much of the story overseas are you watching as well because you see the concerns over in Europe with spreads kind of blowing out. You see slowdown in China as a result of the COVID-related shutdowns. The war in Ukraine bogging down supply chains everywhere. Is there a concern that there could be a spillover effect over into the US economy at this already fragile time?

PATRICK HARKER: I am worried about that. I’m worried about the continued fragility of the supply chains. We saw this again, before even the pandemic hit. Think about one ship and one canal, affected global commerce. So we’ve got a very fragile supply chain network. It continues to be fragile. We’re seeing that play out in real time. And so it’s gonna take some time for that to heal. And that’s why my forecast for inflation, for example, still has us reasonably high next year, until we start to bring it down under 3% the year after.

BRIAN CHEUNG: And then I want to ask about the balance sheet unwind because it seems like that’s been a little bit lost in terms of the story here as well. The Fed beginning the process earlier this month of actively shrinking its balance sheet. Now, how do you think that impacts the overall story here? Because you have some saying, well, does the Fed really want to be withdrawing liquidity during a time of pretty intense market volatility?

PATRICK HARKER: So I’ll go back to where my basic principle. We start that process, we’ve started it now. And we put it essentially on autopilot. That is, we let it run and if we need to vary policy, we do that through the Fed funds rate. In other words, let’s get the balance sheet back into whatever the new normal size is in a methodical way — and that’s what we’re doing. And then if we need to accelerate or decelerate the economy through the use of the Fed funds rate, we do that. Now, it will remove accommodation is what we’re doing with the balance sheet shrinking. How much? Estimates vary, and this is where we need to be cautious and flexible with respect to policy.

BRIAN CHEUNG: And then, you know, that kind of is a segue into the broader volatility that we’ve seen. Ups, downs, deep red days, I mean, it’s been a terrible 2022 for equity markets. You see crypto spilling over. Do you have any sort of financial stability concerns, given the massive swings that we’ve seen in the market? Anything that makes you a little bit worried about something blowing up that can have some sort of larger systemic importance?

PATRICK HARKER: Not at this point, but we need to keep careful watch. The good news is we came into this crisis with a very strong banking sector. So that gives me again, a lot of comfort, but we do need to be cautious and continue to watch.

BRIAN CHEUNG: And then lastly, here, your job is not just to look at regression models or anything like that all day. You do a lot of interaction with households and businesses in the Philadelphia Fed area. Wondering what your message is to them? Because this is a moment that seems like recession is very much top of mind. What’s your message to them when it comes to what the Fed is doing right now?

PATRICK HARKER: Look, we understand the pain is very real. I mean, the pain at the pump, the pain at the grocery store. We get that we need to start bringing inflation down, and that’s what we’re in the process of doing. But we want to do that — at least I want to do that, and I think my colleagues want to do this — in a way where we don’t dramatically impact the labor market.

BRIAN CHEUNG: All right, Philadelphia Fed President Patrick Harker joining us this morning.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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