Schmid says Fed's 3.75% rate not restrictive as inflation persists

Federal Reserve Bank of Kansas City President Jeffrey Schmid said the central bank's 3.5%-3.75% rate lacks sufficient restrictiveness, warning that above-target inflation leaves no room to ease policy — a view that bolsters the case for keeping borrowing costs elevated.

"Now is not the time to let down our guard," Schmid said in a speech Friday in Iceland, adding that he places "little stock in assuming that the most recent runup in prices is transitory within an acceptable time horizon."

The Fed has held its benchmark rate at 3.5%-3.75% since its last adjustment. Markets have shifted from expecting rate cuts later this year to pricing a possible rate increase, according to Reuters. The 2-year Treasury yield rose 8 basis points this week to 4.12% as traders repriced the rate path, while the S&P 500 fell 1.2% over the same period.

Schmid's remarks highlight a growing divide on the Federal Open Market Committee: while some officials see the current rate as sufficiently restrictive to cool inflation gradually, others view the level as barely constraining an economy where "most economic indicators suggest continued steady growth." The debate carries direct implications for bond yields and equity valuations as the next FOMC meeting approaches on June 17-18.

Schmid said the Fed could also use its balance sheet to increase policy restrictiveness, suggesting that quantitative tightening could be adjusted to complement rate policy. "We may need to balance how to make monetary policy more restrictive," he said, while emphasizing that the central bank must retain the option to both raise and lower interest rates depending on incoming data.

"My primary concern is inflation, which is too hot and has been above target for too long," Schmid said. The personal consumption expenditures price index, the Fed's preferred gauge, has run above the 2% target for an extended period. Core PCE stood at 2.8% in the latest reading, down from its 2022 peak of 5.4% but still above the central bank's goal, according to Bureau of Economic Analysis data.

Many Fed officials expect inflation pressures to ease later this year, but that outlook is rooted in hopes of a swift resolution of the Iran war started by President Donald Trump, according to Reuters.

Schmid noted that the U.S. is less exposed to energy shocks than in past cycles, but higher gasoline prices still detract from consumer spending power. He also said his discussions with firms in the Kansas City Fed's district suggest energy producers remain cautious about boosting output despite elevated crude prices, citing "far greater capital discipline" and reluctance to increase production "while prices remain so uncertain."

On the labor market, Schmid said he believes it is "in balance, notwithstanding the potential, though yet unrealized, disruptions of AI." Nonfarm payrolls have averaged 168,000 per month over the past three months, a pace that most Fed officials view as consistent with a stable unemployment rate near 4.1%.

The last time a Fed official used language suggesting policy was insufficiently restrictive was in early 2024, when then-Governor Christopher Waller warned that rates needed to stay higher for longer — a stance that preceded a 40-basis-point selloff in 2-year Treasuries over the following two months and a 3% decline in the S&P 500.

The Fed's next policy decision is scheduled for June 17-18. Economists at Goldman Sachs and JPMorgan Chase both expect the committee to hold rates steady, though Schmid's comments raise the risk that the dot plot — the individual rate projections from 19 Fed officials — could shift toward fewer cuts or even indicate the possibility of a hike.

This article is for informational purposes only and does not constitute investment advice.