- The Federal Reserve will need to raise interest rates by more than markets expect, Larry Summers told Bloomberg.
- Wage growth and labor market demand are still too hot for the Fed's liking following big rate hikes.
Investors should anticipate the Federal Reserve will need to increase interest rates by more than they are pricing in as inflation continues to be stubbornly high, says former Treasury Secretary Larry Summers.
"I suspect [Fed policy makers are] going to need more increases in interest rates than the market is now judging or than they are now saying," Summers said in an interview with Bloomberg that was broadcast Friday. He spoke after the release of the November jobs report showing the economy added 263,000 payrolls, outstripping the 200,000 payrolls economists surveyed by Bloomberg had expected.
Summers also appeared after Federal Reserve Chairman Jerome Powell said this week the central bank has seen "tentative" signs of moderation in labor demand.
"My sense is that inflation is going to be a little more sustained than what people are looking for," said Summers. Wages are a hotspot for the central bank and the November jobs report showed wage growth remained strong, with earnings up 0.6% on a monthly basis. The 5.1% year-over-year rate was ahead of the 4.6% projection by economists.
"We're still in unprecedented territory in terms of the gap between vacancies and jobs," Summers said. "What that's got to tell you is that we got a long way to go to get inflation down where the Fed has said that it wants it to be," he said. The Fed has a 2% inflation target goal.
Summers said investors are pricing in expectations for a 5% terminal rate for the fed funds rate. "I think that's likely to be low because I always try to look for possible errors and four [percent] seems almost impossible and six is certainly a scenario we can write. And that tells me that five is not a good best guess for where it's going to be."
The fed funds rate was at a range of 3.75%-4% after the central bank last month raised it by 75 basis points, the fourth consecutive increase of that size. Investors were pricing in expectations the Federal Open Market Committee at its December 13-14 meeting will reduce the size of its next rate hike to 50 basis points. That move would bump up the benchmark rate to the 4.25% to 4.5% range.
At the same time, the Fed will likely have difficulty steering the economy into a soft landing, Summers said.
"There are all these mechanisms that kick in. At a certain point, consumers run out of their savings, and then you have a Wile E. Coyote kind of moment where consumption falls off," he said, referring to the Looney Tunes cartoon character that perpetually falls from cliffs.
"At a certain point people start putting their houses on the market, and then you see house prices falling and then other people rush to put them on the market. At a certain point, you see credit drying up and when credit dries up, people can't pay back their old borrowing," said Summers.
The November consumer price inflation report is due on December 13. Economists surveyed by Bloomberg project a month-over-month rise of 0.4% in core inflation from 0.3%. October's year-over-year headline figure stood at 7.7%, backing off a four-decade high.