MNI INTERVIEW: Fed Will Cut But Move Slowly: Ex-IMF US Chief

The Fed will be cutting interest rates in the second half of 2023 as policymakers slowly adjust to an economy driven to recession by a credit squeeze and the lagged effect of past rate hikes, Desmond Lachman, former head of the IMF division tracking the U.S. economy, told MNI.

“The Fed will be slow to make the turn” to rate cuts including a pause next meeting, said Lachman, former IMF western hemisphere department chief and deputy policy development branch director, now at the American Enterprise Institute.

“Markets are right in saying the Fed is going to be in cutting mode pretty soon, because you will see the economy in a real recession, you’ll see real problems in the banking system,” he said. “Markets might have their timing a bit wrong, or thinking that he’s going to cut very fast.”

Investors are back to pricing in fed rate cuts starting as early as June. That would undo Wednesday's quarter-point increase and undercut the FOMC's dot plot showing a year-end policy rate of 5.1% with Chair Jerome Powell saying further tightening may be needed to curb inflation.

LEAST BAD OPTIONS

Powell “probably chose the least of the bad options that he has,” Lachman said. Following through on earlier signals for a 50bp hike following the Silicon Valley Bank collapse would have been too drastic and pausing viewed as a lack of confidence in the financial system, he said.

Cutting interest rates near zero during the Covid pandemic fostered dangers being exposed by bank failures and there will likely be more "accidents" making lending scarce and more expensive, said Lachman. Depositors of mid-sized banks will likely pull their money with the government saying it won't give blanket insurance, he said.

The Fed's aggressive rate hikes will also hit the economy this year given the lags in monetary policy, he said. “Those two things are already going to cause, at least in my view, a real recession. If you get a real recession the inflation problem will cure itself.”

“The Fed’s in an impossible position; it can’t do both things” in managing the economy and financial stability, he said.