MNI INTERVIEW: Fed Overtightened But Will Wait 'Til May-Harvey

The Federal Reserve has overtightened monetary policy and needs to start cutting interest rates soon in order to avoid a recession, but policymakers are likely to wait until May before they start reducing borrowing costs, Campbell Harvey, a former visiting scholar at the Fed's Board of Governors told MNI.

"The Fed pushed rates unnecessarily too high and to mitigate the risk of much slower growth or recession they need to reverse some of that," said Harvey, who pioneered research showing movements in the yield curve could predict economic turning points.

Harvey expects the Fed to begin its easing cycle with a 25 basis point cut in May.

"I expect the Fed will do nothing in January and I expect that the Fed in March will likely do nothing also but have a discussion and signal cutting at the next meeting." A number of ex-Fed officials have told MNI the Fed is likely to hold a patient stance. (See: MNI INTERVIEW: Ex-Fed's Lockhart Sees No Rush To Cut In 1H)

The FOMC is widely expected to hold interest rates steady at a 23-year high of 5.25-5.5% next week while softening its guidance on future action to indicate a more neutral stance that opens the door to rate cuts later in the year.

DELAY RISKS A RECESSION

For his part, Harvey wants to see swifter cuts sooner, arguing overall inflation is steadily falling toward the central bank's 2% target and, when substituted with market rents, is already undershooting it.

"I would like to get rates kind of back to normal which would be like 3% to 3.5%" this year, he said, adding he would like officials to start with a 50 basis point cut in March.

"The wait and see attitude is fraught with danger. The risk is that we get into a more serious downturn and it could be substantially mitigated if the Fed moved sooner rather than later," he said. "The difference between slower growth and a recession is really in the Fed's hands." (See: MNI INTERVIEW: Taylor Rule Supports March Cut -Ex-Fed's Tracy)

Harvey, whose work discovered that for decades an inverted yield curve has preceded a U.S. recession, said the curve is currently pointing to slower growth in 2024, but also noted pent-up demand is fading and household excess savings are dwindling. The yield curve tends to un-invert before the start of recessions, Harvey said.

"The elephant in the room is the inverted yield curve and that indicator is eight out of eight in terms of calling recessions since the 1960s, without a false signal," he said.