MNI INTERVIEW-Fed Rates To Peak Well Above 5%, No Cuts in 2023

The Federal Reserve will likely need to raise interest rates above the 5.1% peak predicted at its December meeting, and sticky price pressures mean they will not be able to reduce borrowing costs in 2023, a former senior research advisor to the San Francisco Fed told MNI.

“Inflation is going to be declining very slowly for the next 12 months,” said Eric Swanson, also a former Fed board economist who is now at the University of California at Irvine, in an interview following the release of the Fed’s December minutes.

“The FOMC is still a little on the low side. A couple of FOMC members are converging to my view, which is that they’ll have to raise to 5.5%, maybe even a touch higher, but most of them are not there yet.”

The Fed’s December minutes were generally viewed as hawkish, pushing bond yields higher and stock prices lower as markets digest the idea that a central bank pivot might not come as quickly as investors had hoped. In particular, the minutes said that not a single FOMC member is penciling in rate cuts for 2023, a view that Swanson agrees with.

“There’s no way they’re going to ease. They’ll tighten a few more times. They might kind of wait and see and hope inflation comes down a little more,” he said. “But if they just go to 4.9% or 5% I don’t think that’s going to be enough. I think inflation is still going to be running quite close to that.”

POSITIVE FUNDS RATE

The problem for the Fed is that in order to be truly restrictive, rates have to be above the rate of inflation, probably to a substantial degree. (See MNI: FOMC To Signal Path To 5% Next Year - Ex-Fed Officials)

“You want the real federal funds rate to be positive and probably a couple of percent. They’ve really got to get the federal funds rate above inflation and it’s not even above inflation yet,” said Swanson.

The Fed raised interest rates in December to a range of 4.25-4.5%. Inflation as measured by the CPI came in at 7.1% in the year to December, while the Fed’s preferred PCE gauge was up 5.5% on the year as of November.

Most Fed members are “thinking they’ll just have to go to a little over five – that’s just too optimistic, unless inflation really drops, and that’s too optimistic."

NO RECESSION

Swanson said markets might be pricing in rate cuts toward the end of this year because many are expecting the economy to enter a period of contraction. But he believes that, with monetary policy still arguably stimulative because real rates remain negative, and the labor market showing continued strength, a significant slump is not in the cards.

“The market thinks there’s going to be a recession,” said Swanson. “The Fed doesn’t see that, I don’t see that. Even a recession would not be enough to make the Fed cut, but they would certainly stop the rate increases.”

ADP reported a stronger-than-expected gain of 235,000 new private sector jobs for December, and analysts are forecasting another solid rise of 200,000 in tomorrow’s official payrolls report from the BLS.

“Labor markets continue to be very tight, that’s going to continue to put upward pressure on inflation. Inflation has always been persistent, it’s really tough to get it moving one way or the other,” Swanson said.