Steve Chiavarone, Federated Hermes’ head of multi-asset solutions, summed up the market’s perception of the Fed’s interest rate trajectory last week in a single line.
“I think they’re going to cut this year – I just think they don’t know it yet,” Chiavarone stated to Bloomberg Radio.
Is he correct? It is not intended to disparage Chiavarone; his viewpoint is undoubtedly representative of Wall Street’s present assessment of the probable trajectory of interest rates.
For example, the fed funds rate gets “pretty low, pretty quick,” according to Vincent Reinhart, chief economist at Mellon Investments and a former top aide of longtime Fed Chair Alan Greenspan, yet speculators in derivative markets predict no Fed action until September.
Despite claims that it is concerned about inflation, it is believed that the Fed will act quickly to promote growth. Traders predict that by June of next year, the central bank will have lowered its benchmark rate by 100 basis points, to between 3.25 and 3.5%.
However, a number of leading economists believe that the market is overlooking some important details.
“I don’t think the market’s confidence that the Fed will cave in is correct,” commented Ethan Harris, who was BofA Securities’ head of global economic research before that.
He pointed out that despite criticism that its 2% inflation objective is unreasonably low, the Fed has obstinately maintained it and recently orchestrated one of the fastest tightening cycles in history in 2022 and 2023.
According to Harris, the perception that the Fed will swiftly lower interest rates is a result of the Fed’s tardiness in launching its campaign against inflation in 2022. For months, Fed Chair Jerome Powell maintained that inflation was “transitory” before changing his mind and raising interest rates and halting asset purchases.
“People are extremely critical of how the Fed was slow to react, and that has influenced perceptions of whether this current Fed is hawkish or dovish,” Harris stated.
However, he continued, the Fed’s aggressive approach of raising interest rates demonstrates its commitment to fighting inflation.
“I’m comfortable that the Fed is putting a big weight on inflation risks now and they will not just ignore a serious, sustained pickup in inflation this year,” Harris stated.
According to two former Fed employees, Powell is now motivated by ideas about his legacy as well. Powell’s term expires in May of next year, and considering how publicly the president has criticized Powell, it is very improbable that he will be nominated again.
David Wilcox, an economist at the Peterson Institute for International Economics and Bloomberg Economics and a former senior adviser to three Fed chairs, stated, “If there is one thing that is 100% clear, nobody on the [Federal Open Market Committee], and least of all Powell, wants to go down in history as having lost an inflation fight for a second time around.”
Powell has stated in recent lectures that the Fed “will keep at it” until inflation reaches the 2% target.
According to Wilcox, it alludes to the renowned Fed Chair Paul Volcker, who controlled inflation in the late 1970s and early 1980s. Wilcox pointed out that Volcker’s memoirs was titled “Keeping At It: The Quest for Sound Money and Good Government.”
“Anybody who doubts that is on the wrong side of that bet,” he stated.
In one way, Wilcox said he understood Chiavarone’s point of view: Nobody knows when or if the Fed will make its next move—a rise or a reduction. He noted that the current perspective is even more uncertain as a result of the back and forth this week on the relevance of the tariffs imposed by the Trump administration.
At the time, Harris concurred that there is simply too much uncertainty, calling the Fed “literally a deer in the headlights.”
“There is an SUV coming from one direction and a Hummer coming from the other direction,” he stated.
Additionally, consumers run the danger of being concerned about rising inflation, which could have a self-fulfilling effect. However, a number of soft data points to a significant potential decline in the U.S. economy.
Harris stated, “Of course they are going to wait,” in reference to the Fed.
Would the central bank raise interest rates at all? Yes, according to Wilcox. He stated, “A hike is entirely in the realm of possibility,” implying that the Fed may need to raise interest rates in order to curb inflation.
According to Harris, the Fed will have to raise rates if inflation increases and consumer expectations rise as well, even though the bar for a rate hike is rather high.
According to Wilcox, the Fed may soon have to make these difficult decisions. He pointed out that if corporations reduce their investment and consumers cut back on their spending, the economy may be on the verge of “an air pocket” of significantly slower growth.
Wilcox remarked, “On its own, that would warrant a rate cut – but of course the Fed can’t do that, because the situation is not that simple,” alluding to the intricate and continuous inflation picture.
