Wharton professor Jeremy Siegel outlines exactly what needs to happen for the Fed to stop raising interest rates

• Wharton professor Jeremy Siegel said interest rates are going to fall dramatically this year for three reasons.
• Negative job growth, falling inflation, and a mild recession will spur the Fed to lower rates, Siegel said.
• Siegel stands by his forecast for stocks to rise upwards of 15% in 2023.

Wharton professor Jeremy Siegel expects interest rates to fall dramatically in 2023 for three big reasons, and that should cause the Federal Reserve to pull back on its tightening campaign and help boost stock prices higher.

In an interview with CNBC on Thursday, Siegel said he was encouraged by Federal Reserve chairman Jerome Powell's FOMC speech on Wednesday, as Powell finally acknowledged that inflation is actually falling.

"It was much more two sided. He acknowledged that the housing sector is really a faulty indicator," Siegel said. "He's acknowledging a lot of the things I've talked about... that inflation has come down absolutely dramatically."

The next step is for the Fed to pause its interest rate hikes, according to Siegel, which he believes will happen in the coming months. And from there, it's likely that interest rates fall in a big way. Here's what could spur such a move, according to Siegel.

First, a negative month of payroll growth would be the spark that causes the Fed to rethink its position on interest rates. And that's a real possibility given the slew of recent job cuts that have impacted the tech sector.

"All we need is one negative payroll month... I think that really changes the whole narrative...We see the labor market break one way or another, I don't think any more increases are on the table," Siegel said.

Second, a weakening economy would help push down interest rates as growth slows and the Fed shifts to a more dovish stance. Finally, the dramatic slowing of inflation, if it continues, would force the Fed to consider potentially cutting interest rates.

"I really think we're going to have a large decrease in rates in the second half of the year because of the weakening economy and because of the dramatic slow of inflation," Siegel said.

But the scenario of falling interest rates, if it occurs, could still lead to a strong year for the stock market. Siegel stood by his forecast for the stock market to gain upwards of 15% this year.

"If you bring down that discount rate, the market will say 'hey, a mild recession or even a moderate recession for a year, I'll take that.' And that's why I think the market still has a good change of getting that 10% to 15% gain," Siegel said.

Another reason why stocks could see gains even if job growth stalls and the economy enters a mild or moderate recession, is because productivity is poised to see big gains, according to Siegel.

"We added 4.5 million jobs and had almost no increase in GDP. That's because of the collapse in productivity. [If] we get a rebound in productivity, we could have much weaker payroll numbers, GDP may not do as badly, and firms may be able to cut excess individuals that they hoarded in the last two years in order to control costs," Siegel said.

"So earnings may not go down anywhere near as much as a lot of people feared even though we would have a recessionary payroll type of data which could encourage the Fed to reduce interest rates much more quickly," Siegel concluded.