The Fed is likely to raise interest rates more than markets now expect, says Riccardo Reis, an economist at the London School of Economics.
“The markets are going to shake,” Reese told MarketWatch on the sidelines of the American Economic Association’s annual meeting in New Orleans.
All risks to the upside. He added that the rate of 5.5% is the minimum.
The Fed last month raised the maximum of its benchmark interest rate range to 4.5%. The central bank set the final interest rate at 5.25%.
Investors who trade in the federal funds futures market now expect the Fed to stop increasing when interest rates reach 5%.
Rees believes that the central bank will eventually raise interest rates.
He said the Fed is fatigued by its failure to recognize the continued upward movement of inflation in 2021.
“So I think they’re biased toward overemphasis,” he said. “Either legitimately or because they’re worried about fixing their past mistake, there will be more tightness than you think.”
The economy is at a turning point, Reese said, and the Fed faces some “tough calls.”
The key to moving forward is the wage path.
The workers need to increase their wages because their salaries have not kept up with inflation.
So, the Fed will have to measure whether the wage increase is too big, right or too little, he said.
If wages don’t rise too much, he said, inflation could quickly return to the Fed’s 2% target.
If wages rise in line with productivity, the Fed won’t have to raise too much and inflation will drop to 2% in a few years.
This will be difficult because productivity is a difficult economic variable to measure.
Rees warned that if wages rise, it is likely that companies will continue to raise prices, starting a wage and price spiral.
He said the Fed may overreact to higher wages.
There is a scenario where prices go up “much more,” Reese said. But there is a range – it can be “much more” or “much more” or “more than that”.
Reese said he was sympathetic to the idea that raising the unemployment rate to 5.5% wasn’t such a terrible outcome if it meant a return to low inflation.
The unemployment rate was 3.5% in December.
It rose sharply on Friday when the government reported a relatively slow increase in wages in December. The yield on the 10-year Treasury note TMUBMUSD10Y,
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