MNI INTERVIEW: Fed May Need To Raise Rates Above 6% - Reis

The Federal Reserve will need to tighten more than investors or policymakers believe, raising interest rates to at least 5.6% and possibly above 6% to subdue inflation, Fed academic consultant Ricardo Reis told MNI.

The chance the Fed hikes beyond 6% ranges between 25% and 50%, Reis said. That's a stronger view than officials who in December signaled two more 25bp hikes in March and May before peaking just above 5%. Some officials have since said there's a risk rates could edge somewhat higher.

Reis' baseline is for the U.S. central bank to raise the current 4.5%-4.75% fed funds target range to between 5.5% and 5.7% in 25bp steps, adding he sees a 50bp move as an option.

"I don't think that would be a dreadful mistake to do a 50 basis point," he said in an interview. "I can see the argument for why to do it and I would certainly not put it off the table."

RECALIBRATION

A stronger-than-expected 6.4% jump in CPI in the year to January -- along with seasonal revisions leaving the pace of core CPI inflation hotter than first thought --have cemented expectations for further hikes. That's a shift from earlier this year when the inverted Treasury yield curve signaled many investors saw the Fed cutting rates late in 2023 as a weakening economy pulled down prices.

"Inflation is likely to keep on coming down over the next few months, absent new shocks. The real question is how fast it will come down, especially where will we be 10 months from now at the end of the year," he said. "Bar another energy shock it will be somewhere in the neighborhood of 3% to 5%, still far from the 2% objective."

A stronger-than-expected labor market also gives the Fed room to continue its aggressive focus on inflation, Reis said. He's expecting a mild recession in the next 12 to 18 months, where the jobless rate climbs only a bit more than a percentage point from today's historic low of 3.4%.

"Raising rates has less of an effect on employment than we might have thought," he said, "which will therefore liberate you to focus interest rates even more on inflation." (See: MNI INTERVIEW: Employment Could Be Less Sensitive To Fed Hikes)

KEEP ON DELIVERING

Reis, a professor at the London School of Economics who also advises the Bank of England and the Riksbank, said another alternative is keeping high rates for longer than laid out in the Fed's projections. In December, policymakers’ median forecast was for rates to peak at 5.1%.

Tighter policy is also needed to solidify the Fed's inflation-fighting credentials that were threatened by the recent run-up in prices, Reis suggested.

"Eighteen months ago the Fed had lost its anchor temporarily," said Reis. "Now the anchor seems to have been reestablished."

"Now you need to keep on delivering," he said. "All you have to do now is to stay steady in bringing inflation down."