““Markets expecting a pivot and the Fed cutting rates next year to me sounds delusional.””
— Nouriel Roubini
At this point, investors have heard from dozens of economists and analysts — including a handful of Federal Reserve branch presidents — who have said that markets are over-estimating the likelihood that the Fed will be in a position to start cutting interest rates next year.
But few have expressed this thought as colorfully as Dr. Nouriel Roubini, the economist known to many as “Dr. Doom” for his often downbeat predictions. Roubini told Bloomberg Television during a recent interview that investors are “delusional” if they truly expect a Fed pivot to arrive soon.
U.S. stocks and bonds have surged in the past month since tumbling to their mid-June lows as futures traders have priced in a high probability that the Fed’s benchmark interest rate target will peak later this year at around 3.75%, before starting to decline as soon as next summer, according to the CME’s FedWatch tool.
Another widely followed gauge of policy-rate expectations is the Fed’s “dot plot” — a collection of projections for benchmark interest rates from senior Fed officials. According to the latest update released after the Fed’s June policy meeting, the Fed funds rate is expected to reach 3.375% by the end of 2022, before rising to 3.8% by the end of 2023.
However, Roubini believes both of these projections are too optimistic. Instead, he expects the central bank will need to raise its benchmark rate to a peak above 4% — perhaps even as high as 5% — if it wants to succeed in wrestling inflation back down toward its 2% target while also keeping inflation expectations in line.
“The Fed funds rate should be going well above 4% — 4.5%-5% in my view — to really push inflation towards 2%,” said Roubini, who is the CEO of an eponymous research shop.
“If that doesn’t happen, inflation expectations are going to get unhinged,” he added.
Roubini added that although inflation may have already peaked, the Fed’s monetary posture isn’t nearly restrictive enough to quickly subdue price pressures.
“It might have peaked but the question is how fast is it going to fall? With the Fed still having real rates on the policy side highly negative, I don’t think the monetary policy is tight enough to push inflation toward 2% fast enough,” Roubini said. “We are still in a severely inflationary environment, not just in the United States but around the world.”
The latest reading from the consumer-price index, released last week, found that headline inflation retreated to 8.5% from a 41-year high of 9.1% in June, largely thanks to the drop in energy prices.
However, a gauge of “core” inflation, which strips out volatile food and energy prices, still rose by 0.3% in July thanks to increases in the cost of rent, and the cost of owning a home — among other factors.
During a recent column for Project Syndicate that was published by MarketWatch, Roubini warned that the era of stubbornly low inflation that preceded the pandemic is over. Instead of a return to the old paradigm, the world will be forced to accept the “Great Stagflation”, driven by secular forces like the rollback of globalization, climate change and other geopolitical factors that will make it more difficult for developed economies to import cheaply made goods from abroad.