According to Ricardo Reis, an economist at the London School of Economics, the Federal Reserve will likely raise interest rates more than markets expect.
“Markets are going to be rocked,” Reis told MarketWatch on the sidelines of the American Economic Association’s annual meeting in New Orleans.
“All risks are on the upside. A rate of 5.5% is the minimum,” he added.
Last month, the Fed raised the top of its benchmark rate range to 4.5%. The central bank has set a terminal rate of 5.25%.
Investors trading in the fed funds futures market now expect the Fed to stop hiking when rates hit 5%.
Reis thinks the central bank will eventually raise rates.
The Fed is burned by not acknowledging the persistent upward movement in inflation in 2021, he said.
“So I think they’re biased towards over-tightening,” he said. “Either legitimately or because they are afraid to right their past mistake, there will be more rigor than you think.”
The economy is at a crossroads and the Fed faces “tough calls,” Reis said.
The key to moving forward is the salary track.
Workers must see their wages rise because their paychecks have not kept up with inflation.
So the Fed will have to assess whether the wage hike is too big, just enough, or too little, he said.
If wages don’t rise much, inflation can quickly return to the Fed’s 2% target, he said.
If wages rise in line with productivity, the Fed won’t have to raise too much and inflation will come down to 2% in a few years.
This will be difficult because productivity is a difficult economic variable to measure.
If wages skyrocket, it would likely prompt companies to keep raising prices, triggering a wage-price spiral, Reis warned.
The Fed could overreact to rising wages, he said.
There is a scenario where rates rise “a lot more,” Reis said. But there is a range – it could be “a lot a lot more” or “a lot more” or “just more”.
Reis said he favored the idea that the unemployment rate rising to 5.5% was not a terrible outcome if it meant a return to low inflation.
The unemployment rate reached 3.5% in December.
rose sharply on Friday when the government announced a relatively slow increase in wages in December. The yield of the 10-year Treasury note TMUBMUSD10Y,
fell to 3.56%.