MNI INTERVIEW: Fed To Hike More Than Markets Expect–Goodhart

The Federal Reserve will likely raise interest rates substantially more than markets are pricing in because inflation will prove stubborn even amid slowing economic activity, former long-time Bank of England member and adviser Charles Goodhart told MNI.

Wall Street is betting the fed funds rate will peak around 3.6%, while Fed officials have signaled rates will end the cycle around 3.8%.

“The problem is that you won’t get inflation back to target unless you get wage growth back to a consistent level,” Goodhart said in an interview. “And it will take quite a lot more to get wage growth down, which is one of the reasons that a recession is likely to be deeper than the Fed indicates.”

The U.S. inflation surge seen over the past year took a breather in July on the back of lower energy prices with annual CPI dipping to 8.5% from a 40-year high of 9.1%. Price pressures are sufficiently widespread and persistent that inflation will likely end the year around 6% to 7% – more than three times the Fed’s 2% target, Goodhart said.

Official rates will have to go “a lot higher than appears to be the case at the moment in market expectations. Take market expectations and you add on something like 1.5% to 2%,” he said. (See MNI INTERVIEW: Fed’s Bullard-Rates Could Be ‘Higher For Longer’)

MISGUIDED EMPLOYMENT ASSUMPTIONS

The Fed’s hope for a soft landing appear misguided given that tamping down wage growth requires a higher jobless rate of at least 4.5% or 5%, he said. The unemployment rate fell in July to 3.5%, matching a 50-year low.

“The rate of growth of real output has been slowing down, partly as a result of the hikes in interest rates, but the labor market remains fairly tight,” said Goodhart. “The Fed is making weird, wild assumptions about the steepness of the Beveridge curve, which are unlikely to be realized.”

Goodhart, author of an influential recent book arguing reduced global labor supply will lead to higher cost pressures, cited the debate between Fed economists and outsiders including former IMF chief economist Olivier Blanchard and former Treasury Secretary Larry Summers.

“When it comes to discussing macroeconomics, trying to go against Blanchard and Summers is not a very sensible idea,” he said. “One of the questions is when is the Fed going to realize that it’s going to take more in the way of (slowing) which will require further interest-rate increases to turn the labor market around significantly.”

QT OPTIMISM RISKS

Reducing the Fed’s USD9 trillion balance sheet might also be rougher than officials hope, Goodhart said. (See MNI INTERVIEW: Market Strains Could Ramp Up QT Effect)

“The spat or worse between China and the U.S. being on the rise, the Chinese are beginning to worry about their vast holding of Treasuries,” he said. “If you’ve got a combination of QT and some of the foreigners withdrawing funds, you could at some point get a break in the T-bond market. It hasn’t happened yet. I find markets still excessively optimistic.”