Michel Euler/AP Photo
- Larry Summers sees turbulent times ahead for investors, who are too convinced inflation is cooling.
- The former Treasury Secretary said the Fed could tighten more than expected to hit its inflation goal.
- He laid out why the Fed could go further than the two 25-basis-point interest-rate hikes now priced in.
Larry Summers has warned investors have a bumpy ride ahead of them as reality sinks in about what the Federal Reserve still has to do to combat inflation.
Markets are too complacent that price pressures have cooled to the point where the US central bank might consider easing up on monetary tightening, the former Treasury Secretary suggested.
"We're headed into what's likely to be a turbulent period," Summers said Friday on Bloomberg's Wall Street Week with David Westin,
"I'm not sure we're on a trajectory that's going to get us to 2% inflation without more interest-rate increases than the market is now anticipating."
Last week, Summers referred to elevated price rises as a half-way healed "infection" that could worsen if not treated properly.
US headline inflation soared to a 40-year high of 9.1% in June and came in at 6.5% in December — well above the Fed's target of 2%.
Those price pressures prompted its policymakers to raise interest rates from almost zero in March to nearly 5% today, and to signal further increases could be coming. But the Fed slowed the pace of tightening at its meeting this month, with a 25-basis-point hike.
Lately, the better-than-expected inflation data over recent months has given hope to the idea that interest rates could start coming down earlier than expected. Stocks enjoyed a strong start to 2023 — with the S&P 500 up over 9% on February 2 — as investors welcomed the possible softening in the risk of recession.
"I think the consensus has become substantially too complacent about inflation for a variety of reasons," Summers said. Markets are currently pricing in another two 25-basis-point hikes by the Fed.
Though it's fallen, the inflation rate is at levels that would have been unimaginable two years ago, according to the Nobel Prize-winning economist.
"And so we haven't come all the way down, or got this fully under control," he added.
But recent comments from Fed Chair Jerome Powell and other policymakers have put ice on investor hopes for an easing in monetary tightening, with talk of a possibility of three 25-basis-point hikes this year. The S&P 500 last week notched its worst weekly run in nearly two months, paring its year-to-date gain to about 6.6%.
In a nod to Sunday's Super Bowl, Summers drew a comparison for the Fed's attempt to ease inflationary pressures with trying to score in football.
"It's easier to move the ball down the field at midfield than it is when you're in the red zone," he said. "And we're getting closer to the red zone with respect to inflation."
Following the surprisingly strong jobs report earlier this month, the probability is for the Fed to go even further than markets expect, Summers suggested.
"So I think with that kind of picture, the prospect that we are not on our trajectory now, where inflation is going to get to the target level," he said.
"And therefore, this tightening cycle is not just about one more, two more, three more 25-basis-point increases, but something more fundamental."
"That's a substantial probability in this environment."