Hike rates

Why the Fed Likely Won’t Hike Rates 50 Basis Points, Economist Says

MKM Partners Chief Economist and Macro Strategist Michael Darda Joins Yahoo Finance Live to Discuss Consumer Price Index (CPI) Data, US Inflation, Market Expectations and Policy from the Fed.

Video transcript

Let’s take a closer look at the CPI report and its reaction today, as well as extrapolating what this will mean for the Fed, of course. Michael Darda is with us, Chief Economist and Macro Strategist at MKM Partners. Mike, good to see you. So 50 basis points – is that what we get in March or do we still need to see the additional CPI report that’s coming out by then and maybe get a bit of Fedspeak? What do you think?

MICHEL DARDA: Well, I’d be a little surprised if the Fed came out 50 right off the bat. I think with those numbers and how the economy performed last year, you could definitely argue for 50. But the reason the Fed probably won’t is that if it did, the expectations of the market would reset to 50 at each subsequent meeting. . And they probably don’t want to risk taking that step and then having to backtrack. So they will probably start more gradually.

They still have seven meetings this year. They can increase rates at each meeting by 25 basis points if they decide it’s necessary. And they can also accelerate the pace of rate increases thereafter.

But let’s step back a bit here and just recognize that even though we have headline inflation of 7 and 1/2% and underlying inflation of 6%, excluding food and energy, the Fed is actually continuing to do QE which did not complete tapering. And the short rates are at 0%. So to say they are behind the curve is a complete understatement.

Michael, to that end, do you think we’re seeing an upward price spiral in this economy?

MICHEL DARDA: We are witnessing a broadening of inflationary pressures. I hear some economists saying, well, inflation has really been driven by the goods sector, and that’s going to subside as the pandemic recedes. Remember that if we look at inflation in services, excluding energy services, we are still running at fairly high levels, around 4%. And the trend for this cycle has actually been higher than the last cycle. So if you extend the trend growth trajectory of services inflation, excluding energy, since the start of the pandemic, we are running above that.

Rents are rising quite rapidly. Salaries are also increasing. And all of these variables are above the trend growth path of the previous cycle. So the idea that this is just some kind of narrow inflation that will go away on its own, I think, is wishful thinking.

So what happens from here, Mike? I mean, is that– this 7 and 1/2% print– are we going to see smaller prints from now on? Is there a risk, even, of seeing this level or more persist, because it looks like… I mean, we keep hearing these calls that the supply chain is loosening up a bit. But I don’t know if it’s enough to make a difference.

MICHEL DARDA: Yeah. I think you have to be careful with fake heads. And so we could very well be at a point where these global inflationary pressures are peaking on a statistical basis. But keep in mind that if inflationary pressures are widening, that’s a floor that continues to rise in terms of whether inflation will decline and how long that decline will last.

The other thing to keep in mind here is one of the flaws occurring in Wall Street research right now is the lack of a consistent model for determining nominal income. And that basically means whether the Fed is behind the curve, on the curve, or ahead of the curve and how we do the macro assessment from there.

If they’re going to start off very gradually and they’re going to continue to lag the curve, we really shouldn’t expect the economy to slow dramatically and inflation to take a long dip. So yes, those numbers could drop at some point in the near future. But my view is that we’re likely to see inflation at least 100 basis points, if not more, above what would be in line with the Fed’s target, which is an average inflation target of 2%.

So we’re way above that now. I think we will continue to be on top. And the Fed will likely lag for most, if not all, of the year, which could set us up for potential challenges well into 2023 should the Fed become more aggressive then.

Before you came, Michael, I was sharing a recent story of my… where the price of my deodorant that I used all the time basically doubled. It’s almost $14 a pop right now. And what did I do? I traded to something that was $7. Have you seen price increases in your own life? And have you tried to negotiate accordingly?

MICHEL DARDA: [LAUGHING]

Well yeah. I… everything is in place. I mean, obviously, food and household goods, you know, rents – and we’re seeing a lot of price pressure in leisure and hospitality. So try to book a vacation somewhere.

So I think we all see it in our day to day lives. I certainly see it. And the question is, if you still have a very hot economy that is rapidly approaching full employment and potentially beyond, can we really expect a large-scale reversal of those inflationary pressures? And I don’t think so.

Thus, the overall CPI could relax a little. But we are still likely to face headline inflationary pressures well above what we were accustomed to during the last cycle. And that will continue until the Fed tightens enough to slow overall aggregate demand in a sustainable way. And then inflation will kick in. But until that happens, we’re going to face persistent above-trend inflation, in my view.

Yeah, something to look forward to. Mike Darda, good to see you. Thank you very much, Chief Economist and Macro Strategist at MKM Partners.