Economists warned that the Federal Reserve’s (Fed) terminal interest rate could exceed 5.5%, which is bound to shock financial markets.
The Federal Reserve announced a 2-point rate hike in December last year, raising the federal funds rate to 4.25%-4.5%, a 15-year high, and expects the terminal rate to rise to 5.1%, and will not cut interest rates until 2024. Investors are now expecting the Fed to stop raising rates when the terminal rate hits around 5%.
However, Ricardo Reis, a professor and economist at the London School of Economics, judged that the Federal Reserve will eventually raise the terminal interest rate, exceeding the current expectations of the market, and the financial market is bound to be affected.
Reis warned: “All risks are to the upside, terminal rates will be at least 5.5%.”
There are signs that Fed officials are unwilling to take any risks. “The Fed is unhappy that it doesn’t realize that inflation is going to continue to rise in 2021, so I think they’re leaning toward overtightening, whether it’s legal or because they’re worried about making up for past mistakes,” Reis said. They’re going to be tighter than the public expects.”
“The economy is at an inflection point, and the Fed does face some tough decisions, and the key is wages,” Reis said.
Federal Reserve Chairman Jerome Powell reiterated many times last year that the current wage increase is “much higher than the level consistent with the 2% inflation rate”, which gives a new “North Star” to the journey against inflation, that is, “wages” will It will be the core of monetary policy this year.
Data from the U.S. Department of Labor on Friday (6th) showed that the number of non-agricultural employment in the U.S. increased by 223,000 in December last year, higher than market forecasts, the unemployment rate fell to 3.5%, and the average hourly wage increased by 4.6%, all worse than market expectation.
“The Fed will have to weigh this year whether wage increases are too much, just enough, or too little,” Reis said. “If wage increases are modest, inflation could return to the 2% target very quickly.”
“Inflation would drop to 2 percent within a few years if wages rose in tandem with productivity without having to raise interest rates so much, but that would be difficult because productivity is a hard-to-measure economic variable,” Reis said. Leading firms to raise prices on their products creates the risk of a wage and price spiral, to which the Fed could overreact.”