"US inflation whistleblower" warns: Fed rate cuts may not match dot plot

According to the financial news app Zhitong Finance, Lawrence Summers, the former US Treasury Secretary and known as the "US inflation whistleblower," recently stated that the market's assessment of the Fed's interest rate cut path is too aggressive. He also mentioned that the potential threat of inflation may prevent the Fed from lowering interest rates in the next few years as indicated by the dot plot. "In fact, based on the dot plot, it seems that Fed policymakers believe that loose monetary policy may go too far, but this poses a significant risk to the potential growth trend of inflation," Summers said in an interview with the media on Thursday.

In the latest forecast chart of the Fed policymakers for the US benchmark interest rate (the "dot plot"), the median expectation for the benchmark interest rate at the end of next year is 3.4%. This reflects the possibility of further interest rate cuts of up to 1.5 percentage points following the Fed's announcement of a 50 basis point cut on Wednesday. Market expectations for the extent of rate cuts are even more aggressive, with interest rate futures markets expecting the Fed to cut rates by 1.75 to 2 percentage points by the end of next year.

Lawrence Summers, the former US Treasury Secretary and Harvard University professor, stated, "If inflation pressures reappear, interest rates will not drop as significantly as predicted by Fed officials in their so-called dot plot." He also warned investors that the financial markets have significantly overestimated the loose monetary policy that the Fed is about to adopt.

Summers, who has long been praised by Wall Street economists as the "US inflation whistleblower," had publicly warned as early as 2021 that US inflation could show a significant increase. He also insisted that the market was overpricing the possibility of multiple Fed rate cuts in 2024 when expectations for rate cuts were high last year. He believed that inflation could rise again and that the Fed severely underestimated the long-term neutral interest rate level.

Higher Long-Term Rates

"I suspect that long-term rates will see a certain degree of increase in the future—possibly a significant increase in 10-year or 30-year long-term rates," he said in an interview.

As of Thursday's US stock market close, the yield on the 10-year US Treasury bond, known as the "anchor of global asset pricing," was around 3.71%, far below last year's historical high of over 5%. This reflects the bond market's very aggressive pricing of the Fed's interest rate path, significantly outpacing the Fed's rate curve.

Former US Treasury Secretary Summers pointed out that over time, higher yield curves will push up US mortgage rates. The recent decline in long-term borrowing costs has only just begun to stimulate the expansion of demand for US housing loans, providing hope for a rebound in demand in the US real estate market.

Summers stated in the interview, "Compared to the potential average level we might expect in the next five years, the mortgage rates people are seeing now may be relatively low." According to statistics from the Mortgage Bankers Association (MBA) of the United States, the 30-year fixed mortgage rate was approximately 6.15% last week, significantly lower than the 6.78% at the beginning of this year. In the five years before the outbreak of the COVID-19 pandemic, the average level of this long-term rate hovered around 4.2%.

Mortgage rates fall from highs of decades

Summers reiterated his personal view in interviews that the Federal Reserve may underestimate the neutral interest rate - the neutral interest rate being the long-term rate level that Fed policymakers believe is consistent with a 2% inflation rate.

Federal Reserve officials did raise their long-term neutral rate expectations in the latest economic data forecasts released on Wednesday Eastern Time, with the median stable benchmark rate expectation starting in 2026 shown in the latest dot plot rising to 2.875%. Federal Reserve Chairman Jerome Powell stated at a press conference that the long-term neutral rate "may be much higher than in the years before the COVID-19 pandemic," when global government bond yields were negative in the tens of trillions of dollars.

Powell stated at the press conference after the rate decision: "We are still not sure where the neutral rate is, we can only understand it through its operation and economic data." Here, if the Fed's benchmark rate is set below the long-term neutral rate, inflation rates will rise.

Summers stated that higher U.S. fiscal borrowing and significant investments in renewable energy and artificial intelligence indicate that the long-term neutral rate is at least 4% - a neutral rate expectation much higher than implied by the Fed's dot plot of long-term neutral rates.

View on Nippon Steel's acquisition of a U.S. steel company

The former Treasury Secretary also expressed appreciation for the Biden administration's decision to delay the review of Japanese steel industry giant Nippon Steel's acquisition of a U.S. steel company. Media reports this week indicated that this Japanese company has been allowed to resubmit its acquisition plan.

Summers said: "We have avoided the catastrophic actions that Pennsylvania steelworkers and large steel users including U.S. automakers and domestic defense industries might have taken." He emphasized: "I hope that in a more stable environment after the U.S. presidential election, with less intense emotions, rational minds can prevail and the market can operate normally."