Why the Fed needs to cut interest rates to lower inflation, according to a JPMorgan strategist

• If the Federal Reserve wants to lower inflation, they need to cut interest rates, according to JPMorgan.
• JPMorgan strategist Jack Manley said lower interest rates would help lower shelter costs.
• "You're not going to see meaningful downward pressure on shelter costs until the Fed lowers interest rates," Manley said. 

If the Federal Reserve wants to lower inflation back to its long-term target of 2%, it needs to start cutting interest rates, according to JPMorgan strategist Jack Manley.

That thinking flies in the face of conventional economic wisdom, which says higher interest rates help combat inflation by lowering aggregate demand, and vice versa.

However, according to Manley, rising shelter costs, which have been a key driver of inflation in this current economic cycle, would actually reverse lower if the Fed started to cut interest rates.

"You're not going to see meaningful downward pressure on shelter costs until the Fed lowers interest rates, mortgages come down to a more reasonable level, and supply comes back on line," Manley told Bloomberg in an interview on Monday.

The housing market has been incredibly tight, with prices staying elevated due to very tight supply and steady demand. Part of the reason housing supply is so tight, aside from not enough homes being built over the past decade, is because most home buyers locked in mortgage rates at below 4%. 

With current mortgage rates closer to 7%, current homeowners have little incentive to sell their house given that any future home purchase would likely result in a much higher mortgage rate.

"I think we're in this funny, peculiar chicken-and-the-egg type situation where you're not going to see meaningful downward pressure on inflation until you see meaningful downward pressure on shelter costs. And you're not going to see meaningful downward pressure on shelter costs, until the Fed lowers interest rates," Manley said.

But the chances of the Fed cutting interest rates this year have plummeted, especially after the release of the March CPI report, which showed hotter-than-expected inflation. 

Core CPI rose 3.8% year-over-year in March, ahead of the forecast for an increase of 3.7% an in-line with February's CPI reading. Since the release of the March CPI report on Wednesday, chances of a Fed rate cut in June plunged to about 20% from about 50% on Tuesday. 

Investors are now pricing in less than two interest rate cuts from the Fed this year, compared to seven projected interest rate cuts at the start of the year. 

Still, according to Manley, the Fed simply needs to bite the bullet and start cutting interest rates even in the face of elevated inflation if they want to get inflation back to their long-term 2% target.

"A lot of what's going on today can be very closely linked to the level of interest rates. You slice and dice inflation and whether you're looking at the headline number, whether you're looking at the core number, you're removing the goods equation, so much of it has to do with the rate environment," Manley said.