Fed's Schmid calls for patience before making any change in interest rates

By Greg Robb

Resilience of economy 'creates some uncertainty' about rate path, Kansas City Fed president says

Hot inflation, strong growth and elevated asset market prices all suggest that the current stance of the U.S. central bank's interest-rate policy is appropriate, Kansas City Fed President Jeffrey Schmid said on Friday.

"Rather than preemptively adjust the policy state, I would prefer to be patient and wait for clear and convincing evidence that inflation is on track to hit our 2% target before adjusting the stance of policy," Schmid said in a speech to a CFTC conference in Overland Park, Kan.

Inflation has surprised to the upside since the beginning of the year and has run at roughly a 4% annual rate during the first quarter, Schmid noted. That's well above the central bank's 2% target.

The Kansas City Fed president said the strong labor market has supported the surge in services inflation.

The Kansas City Fed's broad measure of the health of the labor market - the Labor Market Conditions Indicators - shows that activity in the labor market remains well above its longer-run aggerate level, suggesting the labor market remains "tight," Schmid said.

In his speech, Schmid also called for continuing to shrink the central bank's balance sheet.

"My preference is a much smaller balance sheet with a shorter average maturity," Schmid said.

Minutes of the Fed's March policy meeting show Schmid is in the minority on the balance sheet.

The "vast majority" of Fed officials favor slowing the pace of shrinking the balance sheet "fairly soon," the minutes said.

The Fed bought $5 trillion in assets at the start of the pandemic to help shore up the economy and financial markets. That ballooned the size of the balance sheet to close to $9 trillion. The central bank has been steadily shrinking its balance sheet by up to $95 billion per month since mid-2022, reducing it to about $7.5 trillion.

In Schmid's view, the Fed's large balance sheet gives the central bank too large a footprint in financial markets.

The size of the balance sheet can obscure price signals and distort financial markets, Schmid said. The Fed's securities holdings put downward pressure on longer-term rates and flatten the yield curve. This also stresses the traditional model of borrowing and lending central to the health of many community banks, he added.

Stopping balance sheet runoff "too early" poses a risk of further weakening the financial system's ability to redistribute liquidity quickly as needed.

Schmid said some volatility in interest rates is useful for the financial markets. Smothering the volatility can sow the seeds of future financial market instability, he said.

-Greg Robb

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04-12-24 1339ET

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