Could the Fed’s Pivot on Inflation Backfire?

The Federal Reserve’s December meeting showed the central bank taking a heavily different approach to interest rates. Not the choice to hold the benchmark federal funds rate steady, but the suggestion that the Fed could cut rates three times next year.

The result was an orgy of market activity, with stocks on a roll and investors probably singing “We’re in the Money” to themselves. But some economists are wondering whether the Fed is setting itself, and the economy, up to fail.

Former Treasury secretary Larry Summers said so in an interview with the Financial Times. “I think it’s premature to judge that we have landed softly, because I think that if you look at underlying inflation rates, depending upon your measures, some of them are still running well above 2 per cent,” he said. “If inflation is currently at 2 per cent, it’s not clear that it won’t go back up again. And it isn’t clear that the landing has been soft in the sense that there are a variety of problems — declining flows of credit, inverted yield curves, aspects of consumer behavior, rising evidence of credit strains — that raise the possibility that the landing won’t be soft, if there is one. So at this point, we may soft land on the aircraft carrier, but the landing may be hard, and we may overfly.”

Then again, Summers also was indulging in some revisionism of his own previous stances, like saying that unemployment would have to rise because consumers were driving inflation rather than deep supply chain problems. But he’s also not the only economist worried that things could go awry.

Jose Torres, senior economist with Interactive Brokers, wrote, “While investors are cheering the Fed’s pivot to a more accommodative posture, the shored-up sentiment among market participants has caused financial conditions to become the loosest they have been during the central banks tightening campaign, which is likely to create a renewed bout of inflation. Indeed, all commodities are sharply higher in response to the prospect of re-accelerating inflation in the coming months, a development that I’m incredibly concerned about. I thought Powell was too early in discussing rate cuts, something he remarked as premature just two weeks ago.”

MarketWatch spoke to multiple influential economists for their opinions. “I don’t see how the Fed is going to get inflation down to 2% if they’re going to start cutting interest rates,” said Robert Brusca, president of FAO Economics.

From a CRE view, there is also the question of whether exuberance on the part of investors could start pushing property prices up again, however at a time when getting increased rents to prop up low cap rates might not be possible.