- Larry Summers sees turbulent times ahead for investors who are very convinced that inflation is cooling off.
- The former Treasury secretary said the Fed may tighten more than expected to hit its inflation target.
- They set out why the Fed might go ahead with two 25-basis-point interest-rate hikes.
Larry Summers warns that investors have a bumpy ride ahead as the reality is sinking in about what the Federal Reserve still needs to do to combat inflation.
The former Treasury secretary suggested that markets are satisfied enough that price pressures have cooled to the point where the US central bank may consider easing monetary tightening.
“We are heading into a turbulent period,” Summers told Bloomberg’s Wall Street Week with David Westin on Friday.
“I’m not sure we’re on a trajectory that gives us the 2% inflation the market is anticipating now without interest rate increases.”
Last week, Summers referred to the escalating price rise as a half-healed “infection” that could worsen if not treated properly.
US headline inflation hit a 40-year high of 9.1% in June and eased to 6.5% in December – well above the Fed’s target of 2%.
Those pricing pressures prompted its policymakers to raise interest rates from near zero in March to about 5% today, and further increases may be indicated. But the Fed slowed the pace of tightening with a 25 basis point hike at its meeting this month.
More recently, better-than-expected inflation data in recent months has given hope to the idea that interest rates may start coming down earlier than expected. Shares enjoyed a strong start to 2023 — with the S&P 500 up more than 9% on February 2 — as investors welcomed a potential easing of recession risks.
“I think the consensus about inflation has become too complacent for a variety of reasons,” Summers said. Markets are currently pricing in two more 25-basis-point hikes by the Fed.
Although it has fallen, according to the Nobel Prize-winning economist, inflation is at levels that would have been unimaginable two years ago.
“And so we haven’t fully brought it down, or gotten it fully under control,” he said.
But recent comments from Fed Chair Jerome Powell and other policymakers have put ice on investor hopes for an easing of monetary tightening, with three 25-basis-point hikes likely this year. The S&P 500 posted its worst weekly run in nearly two months last week, trimming year-to-date gains to about 6.6%.
In the run-up to Sunday’s Super Bowl, Summers compared the Fed’s effort to ease inflationary pressures with trying to score in football.
“When you’re in the red zone it’s easy to move the ball down the field in midfield,” he said. “And we are getting closer to the red zone with respect to inflation.”
Summers suggested that the Fed is likely to go further than the market expected, following a surprisingly strong jobs report earlier this month.
“So I think with a picture like this, it is likely that we are not yet on our trajectory where inflation is going to reach the target level,” he said.
“And so, this tightening cycle doesn’t just extend to another, two more, three more 25-basis-point increases, but to something more fundamental.”
“It’s a huge possibility in this climate.”