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Fed rate cut expectations are 'misguided,' former Fed board member says

·4 min read

With declining inflation expectations and lower GDP growth, some investors anticipate the Federal Reserve may pivot to become more dovish with its policy tools.

But Randy Kroszner, a former Fed Governor and current economics professor at the University of Chicago Booth School of Business, thinks the Fed still has a long way to go before rate cuts are in question.

“I think [rate cut expectations are] misguided,” Kroszner told Yahoo Finance Live (video above), “and I think the speakers who have come out have given a very consistent view that that ain’t going to happen, or at least that's not what they expect to happen.”

After some markets began pricing in rate cuts for 2023, St. Louis Fed President James Bullard affirmed on Wednesday that the Fed was adamant about raising interest rates to bring inflation down to its 2% target. Other Fed officials, namely Chair Jerome Powell, have also expressed their unconditional commitment to restoring price stability.

Federal Reserve Chairman Jerome Powell speaks during a news conference at the Federal Reserve Board building in Washington, Wednesday, July 27, 2022. (AP Photo/Manuel Balce Ceneta)
Federal Reserve Chairman Jerome Powell speaks during a news conference at the Federal Reserve Board building in Washington, Wednesday, July 27, 2022. (AP Photo/Manuel Balce Ceneta)

The key issue remains inflation: The personal consumption expenditure (PCE) price index increased 6.8% year-over-year in June, breaking a 40-year record, and the core PCE price index – the Fed’s preferred inflation barometer – rose 4.8% year over year.

As a result, Kroszner said the federal open market committee (FOMC) won't look to lower interest rates in the near future.

“They’re not going to turn down anytime soon,” Kroszner explained. “They’ll keep them raised because they need to make sure inflation comes down and inflation expectations stay down because that was one of the things the Fed got wrong back in the late 1970s. Inflation came up, they started to raise rates, inflation came down a little bit, they brought rates down.”

While the Fed tackles inflation, however, some are concerned that the Fed's rate hikes will bring about more unemployment. The unemployment rate is currently at 3.6%, and the Federal Reserve projects unemployment will stay around 4% over the long run.

Kroszner was skeptical of the Fed's ability to keep the unemployment rate from going above 4%.

The Fed reports that “they don’t think the unemployment rate will go above 4%,” he said. “I don’t think that works because you can’t raise rates so much, have so many negative shocks coming on the economy, and only get the unemployment rate to slightly go above their long-term average. I think it will go higher than that.”

LOS ANGELES, CALIFORNIA - JULY 26: A 'Now Hiring' sign is posted at a Verizon store on July 26, 2022 in Los Angeles, California. As the Federal Reserve continues to increase interest rates, the labor market is starting to show signs of slowing down. (Photo by Mario Tama/Getty Images)
A 'Now Hiring' sign is posted at a Verizon store on July 26, 2022, in Los Angeles, California. As the Federal Reserve continues to increase interest rates, the labor market is starting to show signs of slowing down. (Photo by Mario Tama/Getty Images)

Though even if the unemployment rate were to rise, Kroszner noted that a soft — or softish — landing is still possible.

Should the unemployment rate get into the 5% range, “that’s a significant increase in the unemployment rate but still pretty good by historical standards,” Kroszner said. “That would be a soft landing. The thing that we need to worry about is the unemployment rate may go to 6% or higher because there will be continuing negative shocks.”

There are signs that the labor market is slowing. The Bureau of Labor Statistics' (BLS) Job Openings and Labor Turnover Survey (JOLTS) reported 605,000 fewer job openings and fewer hires in June than in May. BLS will release its July jobs report on Friday, which will provide a much clearer picture of America’s employment situation.

Kroszner advised investors to build a defensive portfolio in the event of a rocky road ahead. He noted that the combination of the Fed’s actions and macroeconomic headwinds makes an incoming recession likely.

“I think we do have an elevated probability of recession,” Kroszner said. “I don’t think that’s baked into the cake, it’s not necessarily. But I think it’s very likely from a combination of higher interest rates and negative shocks from sanctions, geopolitical tensions, et cetera.”

Yaseen Shah is a writer at Yahoo Finance. Follow him on Twitter @yaseennshah22

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