Fed’s Bullard says interest rate policy is ‘behind the curve’ but ‘all is not lost’

The Federal Reserve needs to raise interest rates substantially to control inflation but may not be as “behind the curve” as it appears, St. Louis Fed President James Bullard said Thursday.

One of the Federal Open Market Committee’s most “hawkish” members in favor of tighter policy, Bullard said a rules-based approach suggests the central bank needs to hike its benchmark short-term borrowing rate to about 3.5%.

However, he said bond market adjustments to the Fed’s more aggressive policy, in which yields have surged higher, suggest rates are not that far askew.

“If you take account of [forward guidance] we don’t look so bad. Not all hope is lost. That is the basic gist of this story,” Bullard said in a speech at the University of Missouri.

“You’re still behind the curve, but not as much as it looks like,” he added. Markets are pricing in rates hitting the 3.5% rate in the summer of 2023, a bit slower than Bullard anticipates, according to CME Group data.

The comments come the day after minutes from the March FOMC meeting indicated officials were close to approving a 50-basis-point rate hike but settled on 25 points due to uncertainty around the war in Ukraine. A basis point is 0.01 percentage point.

In addition, members said they foresee the Fed starting to shed some assets on its nearly $9 trillion balance sheet, with the likely pace evolving to a maximum $95 billion a month.

Both moves are an effort to control inflation running at its fastest pace in more than 40 years.

Bullard, a voting member on the FOMC this year, said Thursday that “inflation is too high” and the Fed needs to act. In projections released in March, Bullard called for the highest rates among his peers on the FOMC. He has said he wants to see 100 basis points’ worth of hikes by June. The benchmark fed funds rate now is in a range targeted between 0.25%-0.5%.

“U.S. inflation is exceptionally high, and that doesn’t mean 2.1% or 2.2% or something. This means comparable to what we saw in the high inflation era in the 1970s and early 1980s,” he said. “Even if you’re very generous to the Fed in interpreting what the inflation rate really is today … you’d have to raise the policy rate a lot.”

The Fed uses “forward guidance,” such as its quarterly dot plot of individual members’ interest and economic expectations, in directing the market about where it thinks policy is going.

Judging by moves in Treasury yields, the market already has priced in aggressive Fed tightening. That makes the central bank not so far behind the curve in the inflation fight as it might appear, Bullard said.

“All is not lost,” he said. “The difference between today and the 1970s is central bankers have a lot more credibility. In the ’70s, no one believed the Fed would do anything about inflation. It was kind of a chaotic era. You really needed (former Fed Chairman Paul) Volcker to come in … He slayed the inflation dragon and established credibility. After that, people believed the central bank would bring inflation under control.”

Volcker’s rate hikes did bring down inflation in the early 1980s, but not without a double-dip recession.