The Fed needs to cut interest rates, not raise them, if it wants to tame inflation back to 2%, CIO says

• To lower inflation back to 2%, the Federal Reserve needs to cut interest rates, not raise them.
• That's according to Barry Ritholtz, who argued that rate hikes won't cure the current drivers behind rising prices.
• "Raising rates won't fix these issues and arguably, makes them worse," Ritholtz said.

If the Federal Reserve wants to get inflation back down to its long-term target of 2%, it needs to cut interest rates, not raise them, according to Ritholtz Wealth Management CIO Barry Ritholtz.

That view runs counter to what many economists and the Fed think, with Fed Chairman Jerome Powell set to raise interest rates once again at the FOMC meeting later this month.

While interest rate hikes might have been the correct prescription to lower inflation from its 9% peak in June 2022 to just 3% today, right now the drivers behind inflation won't respond well to more hikes, according to Ritholtz.

That's because today's drivers of inflation include surging apartment rents, a shortage of homes, and too few workers. Those factors could make a big difference, as shelters costs alone account for about a third of consumer inflation.

"Raising rates won't fix these issues and arguably, makes them worse," Ritholtz wrote on his blog last week. "FOMC raising rates from these levels not only makes owners equivalent rent look worse, it reduces single-family home supply, makes houses more expensive, but also sends more people into the rental market — making apartment rentals higher."

The Fed has hiked interest rates aggressively over the past 15 months, sending the fed funds rate from near 0% to in 2022 to just over 5% today. And while the Fed paused at its June meeting, markets expect at least one more increase even with continued evidence that inflation is easing.

Ritholtz's view isn't crazy when you consider that prior to the pandemic, the Fed kept interest rates at near-zero levels for an entire decade and inflation was consistently subdued below 2%.

"The rates, half a point one way or another, are not going to cause more inflation. The problem with houses are there aren't enough of them... You want more homes on the market... give people lower mortgage rates and you'll basically get there," Ritholtz said in a podcast on Wednesday.

Cutting interest rates to lower inflation isn't Ritholtz's only contrarian view on what the Fed should do. He also thinks the central bank should also raise its long-term inflation target from 2% to about 2.5% or 3% because of the trillions of dollars of fiscal stimulus injected into the economy over the past three years.

"After the Great Financial Crisis, the economy was sluggish and zero interest rate policy/quantitative easing had driven rates near zero, 2% was a reasonable upside [inflation] target. But after $5 or 6 trillion in fiscal stimulus, and mortgage rates at 7.5%, perhaps 3% — even 2.5% — makes much more sense as a downside inflation target," Rithotlz wrote.