The Fed won’t be able to lower rates as much as it wants, says ex-Treasury Secretary

According to Larry Summers, Fed officials are underestimating inflation and have promised more rate cuts than they can deliver
By Sam Bourgi
•
08 October 2024
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Larry Summers

The Fed is hinting at much lower rates next year, but according to one influential economist, policymakers will be limited in how far they can go.

In an interview with Bloomberg, former Treasury Secretary Larry Summers said Fed officials probably won’t be able to lower interest rates as much as they want to without reigniting inflation.

In Summers’ view, the central bank has underestimated the so-called neutral interest rate—or the point at which monetary policy neither expands nor restricts economic growth.

As Creditnews reported in July, the Fed raised its estimate for the neutral rate to around 2.8%, with Fed Chair Jerome Powell saying it could go even higher.

“I don’t think that it’s likely that the neutral rate is as low as the Fed believes,” Summers said.

He believes such a rate would bring back inflation thanks to rising household wealth, a growing budget deficit, the expansion of the national debt, and investments in AI and green technology.

When you “take all those pressures downward on savings, upward on investment, and I think the neutral rate has gone up,” said Summers.

If Summers is correct, the Fed may still deliver more rate cuts but not to the extent that was widely anticipated earlier.

The labor market is heating up again

Recent economic data suggest Summers may indeed be spot on.

In September, U.S. job growth blew past expectations as employers added 254,000 workers to payrolls—the largest increase in six months.

Meanwhile, the unemployment rate fell to 4.1%, the lowest since June, while annual wage growth increased to 4%.

For economist and Queens’ College president Mohamed El-Erian, the data was a reminder that “inflation is not dead.”

“This is not just a solid labor market, but if you take these numbers at face value, it’s a strong labor market late in the cycle,” El-Erian told Bloomberg in an interview.

In addition to rising employment, analysts believe the U.S. economy grew at a robust pace in the third quarter.

Economists at Goldman Sachs estimate annual GDP growth of 3% between June and September, which would match the previous quarter’s growth rate.

Against this backdrop, markets are now repricing their expectations for aggressive rate cuts by the Fed.

According to CME Group’s FedWatch Tool, the odds of another 0.5% rate cut in November have fallen to just 1.4%. A week ago, the market price in a 50% chance of that happening.

The consensus estimate now is a standard 0.25% cut in November, followed by a similar reduction in December.

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