NEW YORK (Reuters) - A top Pacific Investment Management Co economist said on Tuesday the U.S. Federal Reserve risks damaging economic growth while trying to restore rates to normal levels and trade tensions spark inflation.
Pimco global economic adviser Joachim Fels said at the Reuters Global Investment 2019 Outlook Summit that rate hikes risk pushing 2-year Treasury yields higher than those on longer-term bonds, which many investors regard as a totem for recession.
“The biggest risk is the Fed moving too fast, the Fed moving above neutral,” said Fels. “The issue is nobody really knows where that neutral rate of interest is.”
The neutral rate is a level of interest that is seen as neither encouraging nor discouraging economic decisions, and is consistent with both stable inflation and strong employment. Estimates of that rate have varied widely.
Fed policymakers are widely expected to raise rates in December for the ninth time since 2015 in response to concerns voiced by U.S. President Donald Trump that the tighter monetary policy was undermining economic growth by making borrowing harder and more expensive.
Fels said the Fed will be undeterred in pursuing at least three more rate hikes through mid-2019. He does not expect a recession until “2020 at the earliest.”
“They want to feel their way toward neutral. Feeling their way toward neutral means that you watch the data, you watch the markets for indications that we may be at neutral,” he said.
“The Fed is quite happy to see financial conditions tighten. That’s what they want to see. Last year, you had the opposite. You had the Fed raising rates but financial conditions ease because the dollar weakened, bond yields didn’t do much and equities went up.”
U.S.-China trade tensions and tariffs - “the key downside risk,” Fels said - could slow growth while also sparking inflation. That makes for a tough challenge at the Fed. Their steady rate hikes are meant to temper growth to sustainable levels and keep inflation in check.
Federal Reserve Chairman Jerome Powell, Fels said, “will gradually tone down the language, but it will be in response to the economy and to data, not in response to Trump.”
Trump recently escalated his attacks on Powell, saying the head of the nation’s central bank threatened U.S. economic growth and appeared to enjoy raising interest rates.
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Reporting by Trevor Hunnicutt in New York; Additional reporting Jonathan Stempel and Herb Lash in New York; Editing by Jennifer Ablan and Matthew Lewis