MNI INTERVIEW: Lagging Fed To Cut 100BP This Year- LaVorgna

The Federal Reserve is likely to cut interest rates by one percentage point this year and officials should already be lowering rates given that inflation has fallen sharply and is set to continue declining, former White House economist Joseph LaVorgna told MNI.

“There’s nothing to suggest that inflation is going to go up, it’s going to go down and therefore I do think the Fed can cut rates,” said LaVorgna, who served as chief economist to the White House National Economic Council, in an interview. “I’m going to say 100 basis points this year.”

LaVorgna thinks the Fed’s hesitation could endanger what now looks like a soft landing, if the lagged effects of monetary policy begin to bite. Real interest rates are at their highest level in around two decades and, while some measures of financial conditions have loosened, borrowing costs for most consumers are still historically elevated, he noted.

“If you look at the rates that households borrow and you do a weighted average of household borrowing costs, they’re at the highest they’ve been at since 2000. Rates are up near 10%, mortgages, credit cards, autos and personal loans,” said LaVorgna, now chief economist at SMBC Nikko Securities.

“If inflation moves down to 2%, you’re going to get real rates that are really really high. I’ve been of the view the Fed should be cutting.”

TRANSITORY, JUST NOT IMMEDIATELY

He said inflation is likely to fall by more than policymakers expect because it was primarily driven, effectively, by transitory forces related to the pandemic – as maligned as that term became after the Fed came under fire for reacting late to the inflation burst starting in late 2021.

His view contrasts with those of others who have warned inflation may prove persistent. With uncertainty high, LaVorgna said that shifts in Fed communications around various data points, starting with a very dovish December decision that was then walked back with hawkish commentary from the whole gamut of Fed officials since, have introduced an added element of volatility into the markets expectations for policy. (See MNI INTERVIEW: US Inflation To Linger As Fed Loosens-Warsh)

“It’s a little bit like elevator economics, you’re up-down, up-down, up-down. Imagine if the February data was weak? We could put May back on the table,” he said about the timing of a first rate cut, now widely expected in June.

Starting sooner would also help shield the central bank from likely, if unfair, accusations of political meddling.

“Let’s say they start in July – that’s not going to look good, right after the conventions. You can’t say that politics aren’t a factor because of course they’re a factor,” he said.

R* CONSIDERATIONS

While the Fed could potentially adjust rates more gradually than in past cycles, cutting by, say, a quarter point at every other meeting, this would only be possible if neutral rates and potential growth have moved higher, a scenario LaVorgna sees as less likely.

Otherwise, the Fed might have to cut aggressively in order to catch up with the pullback in demand likely to accompany receding inflation.

“They could go more slowly but that assumes that R* is higher and we get some term premium in the Treasury market, then I think that could happen,” he said. But, he added: “Unless you believe that potential growth is meaningfully higher than where any realistic plausible estimate is then eventually those real rates will do damage. But I can’t say if it’s this month, next quarter, we just don’t know." (See MNI INTERVIEW: Fed Could Cut As Early As June - Quarles)