„The Fed should not have stuck with high interest rates for this long“
At the next FOMC meeting in September the Fed will very likely cut rates for the first time since 2020. Where do you expect them to go from there?
It's been clear for quite some time that the Fed would cut the Federal Funds Rate in September. Especially in view of the fact that they've achieved their dual mandate, which consists of low, stable inflation and full employment. At this point the only questions are: By how much they will cut and how fast? I would expect normalization – meaning the Fed will reach the equilibrium rate in about 12 months – at the end of 2025 at the latest.
How far will Fed-Chair Powell and his FOMC colleagues go?
They will likely cut by a few hundred basis points. I would then anticipate that the Fed drops the rate to about 3.5%. One thing that is certain is that the equilibrium rate will be higher than before the pandemic. Prior to the pandemic it was around 2.5%.
The reason for that being?
The U.S. economy today is less sensitive to interest rate changes. Both households and businesses have done a very good job of locking in the previously record low interest rates. That in turn is different from the rest of the world and why the U.S. economy has held up so much better than countries in Europe and other parts of the world.
Did the Fed react too late by first referring to Inflation as „transitory“ during the pandemic and more recently by holding on to their restrictive policy for too long?
In late 2021 and at the beginning of 2022 the Fed definitely waited too long to tighten. I don't want to be overly critical since during the pandemic there was plenty of uncertainty about the economy. In hindsight it was, however, a mistake that further fueled inflation.
And now, by clinging to high rates for so long?
Definitely, that is also a mistake. I don't know that it's of existential proportions, but the Fed didn't need to take that chance. They achieved their mandates a while ago. We already had full employment, that's somewhere in the high 3s to 4%, and have blown through that. As to inflation, the Fed has achieved low and stable inflation. For that reason a 5.25 to 5.5% target rate is unnecessary.
Do you also see risks for the financial sector?
Absolutely. The yield curve is still inverted.That puts tremendous pressure on banks and non-bank financial institutions. We saw the results last year with the failure of Silicon Valley Bank and some other bankruptcies. In that sense, the Fed has made mistakes on a few levels. It looks like they'll be able to get through without incurring any damage, but the risks are high and rising.
The Democrats just had their Convention in Chicago. Against the backdrop of high prices will Kamala Harris be able to sell her economic program to voters?
I'll put it this way: The strong rise in inflation in 2021 and 2022 has clearly made (political) life tougher for Vice President Harris. That's the strongest headwind she is facing in terms of potential victory in November. You make the correct point though: Inflation is low today, but the level of prices is high. Voters naturally want to blame someone, and in this case they're blaming the Administration.
Is that justified?
No. The inflation we suffered under in 2021 and 2022 was due to the pandemic, supply chain disruptions and the impact on the labor market. And then the Russian war in Ukraine, which began in early 2022. That sent oil and natural gas prices skyward. Agricultural prices, which contributed to the high grocery prices we're paying now. The reverberations of these are still felt today. Those were the reasons for high inflation, not policies pursued by the Biden-Harris administration.
How would you assess the general economic outlook, are we in for a soft landing, this in spite of the weak July employment report?
I think we're definitely on course for a soft landing. Assuming of course that the Fed follows through and cuts rates, which I am expecting though. The key here is the U.S. consumer, and the consumer is hanging tough. Almost everyone has a job, wages are rising faster than the pace of inflation. Also, as I said before, most homeowners have a 30 year fixed mortgage, so their interest rates have not risen. Home prices are higher and stocks have also risen.
Not all Americans are benefitting though, only about half own stocks and about two thirds their own homes. How about them?
That is definitely the one caveat. Lower wage earners have jobs and their wages are rising faster than inflation, but they borrowed aggressively in recent years to supplement their income. They're not in the same position. I am a firm believer that the economy will flourish if everyone from the bottom to the top is contributing and doing well.
Harris recently presented the key points of her economic plan. Which arguments will she have to drive home during the next few months?
She has to focus on what bothers voters the most, and that's inflation. That includes housing costs, high priced groceries, the costs of healthcare and also skyrocketing insurance premiums. In that sense her policies are not that different from President Biden's. It will be important though how she frames and emphasizes that. It's also important that everything is paid for and doesn't increase the deficit.
Whose trade policy do the Europeans and other countries need to be more concerned about, Trump's or Harris'?
The tariffs Trump has proposed should be disconcerting to all trading partners. If he imposes a 10% tariff on all imports, that affects goods with a total volume of about 3.5 trillion dollars. As Trump showed during his four years in the White House, he typically does what he says. I do not think Harris would go that far. Similarly to Biden she would stick with tariffs pertaining to strategic interests, specifically with regards to China. Solar panels being one of several examples. All of these however would only affect about 18 billion dollars worth of goods, only a fraction of Trump's.
The Interview was conducted by Peter De Thier.
