The Federal Reserve may have to raise interest rates further to fight stubborn inflation amid a resilient US economy, according to Pacific Investment Management Co.’s Richard Clarida.
“Progress on inflation has stalled since the summer, and we are not seeing labor market slack,” the former Fed vice chair told Tom Keene Thursday at Bloomberg’s ‘Future of Fixed Income’ conference in New York. “The good news for the Fed is that expected inflation is pretty well anchored.”
Surging Treasury yields in recent weeks have prompted investors to dial back wagers that the central bank will boost borrowing costs in the months ahead. Swaps traders are pricing in just 8 basis points of further tightening at the central bank’s January meeting, which corresponds to the expected policy peak, suggesting a roughly 32% chance of another 25 basis point hike, according to data compiled by Bloomberg.
The Treasury market selloff that earlier this week drove the 10-year yield above 5% for the first time since 2007 reflects multiple drivers including bond supply, the end of quantitative easing and “Jay Powell’s higher-for-longer” message, Clarida said.
The Fed chair “is doubling down on higher-for-longer and has a committee behind him,” Clarida noted. “The longer bond yields stay at these levels, the more we will see the effects of these rates on the economy.”
Still, he was quick to point out that the transmission of monetary policy through to the broader economy is evolving, noting that companies have “termed out debt and consumers locked in low 30-year fixed rates.”
The global economic adviser at Pimco pointed out that a bigger challenge for the central bank may be deciding when to start cutting interest rates.
“Where the discussion gets interesting, is a situation where the Powell Fed starts to cut rates and inflation is not back to 2%,” he said. “Powell would like 2.1%, but it could be 2.6%, 2.7%. By next summer if we are there, then the Fed can think about lowering rates and do that before getting inflation to 2%. The question is does that happen early in 2024, or later as inflation proves sticky.”
As for the dollar’s strength in recent years, he noted that the greenback “does tend to go in these long waves once every 10 years. Once the Fed does adjust rates downward, it will close rate differentials and the dollar will return to a more normal level.”
— With assistance by Edward Bolingbroke