The Fed has to hike interest rates this year, says SMBC's Joe Lavorgna

[00:00:00] Speaker 1: Joining us right now, former Biden Treasury official Natasha Saron. She's a Yale Law School professor, president and co-founder of the Budget Lab, also former Trump Treasury official Joe LaVornia, and he is CMBC's chief economist. What do you think about all this? [00:00:17] Speaker 2: So I think where we are this week is we got an inflation read that was lower than expectations, but still pretty high. We're in the mid threes. We have consumer retail sales holding up pretty well. We have jobless claims indicating what the jobs numbers have been indicating for the last few months, which is the labor market is doing pretty well. And so I think where we're looking at a picture that is starting to form of an economy where inflation is really a core issue. And remember, all of these are backward looking indicators, except for what Rick was saying towards the end on business indicators. And that means that we're not actually capturing a bunch of what is happening with respect to the conflict in Iran, where I suspect upward pressure on oil prices and gas prices is going to continue in the next few weeks. [00:01:03] Speaker 3: Joe, you agree with that? I do. I mean, the economy is booming, but there is certainly inflation pressure. Today's or this week's data was obviously excellent, as Natasha mentioned. However, given the fact we're going to have double digits in the mid to high teens for CapEx and GDP, the retail sales are strong, the labor market shows no signs of weakening now. It actually appears to be firming. Claims are super low. You've got monetary policy that's very easy. And inflation will not go back to target without some help from the Fed. Last year, Andrew, we got 75 basis points in easing from the Fed because there was concern about the labor market. Those concerns now are misplaced, and the inflation outlook is more uncertain. It's more fraught now than it was six, seven months ago when the Fed was easing or contemplating further easing. So, yes, the economy is good, but it's going to need some help from the Fed to kind of slow things down. [00:01:58] Speaker 1: So, Joe, are you of the view the Fed and the new Kevin Walsh Fed is going to raise interest rates, lower interest rates? We talked to Judy Shelton. She thinks you don't even have to touch the interest rates, that there's sort of other tools with which she can use. [00:02:13] Speaker 3: Well, like, I like Judy. I mean, but the fact is that monetary policy is a very blunt instrument, and the Fed funds rate is the primary tool to do so. The Fed is not going to be shrinking its balance sheet by selling assets, so it just leaves them the Fed funds rate. And it's clear with this AI boom that the neutral or real rate is higher. That jives with Kevin's view that the productivity story is going to be positive and play out. But if you're worried about inflation, and as Natasha said, it's been consistently elevated. The core rates are still well above 2%. You look historically and say, OK, when in the past has inflation, when you're at trend or better trend growth, has inflation ever gone back to where you want it just magically? Chris Waller made the same point in his speech this week. So the Fed, in my view, has to hike, Kevin will hike, and it will be this year. What do you say? [00:03:01] Speaker 2: I so agree with Joe, and I actually think another person who agrees with Joe is Kevin Warsh. You heard him in testimony yesterday saying that, you know, we shouldn't make anything too much of any one particular data print that's showing inflation below expectations. That struck me, too. Inflation is, like, my focus, and it is important for us to, and the Fed will do everything in its power in order to be able to effectuate on the price stability side of the mandate. So he actually was sounding like Kevin Warsh of old with respect to his focus on inflation. [00:03:28] Speaker 4: He said they're not going to agonize. Like, if I need to raise, I'm raising. And I'm not, you know, I'm just going to be here after. Because I think Judy thought that you don't have to touch the rate. Judy always thinks that, you know, that's her whole thing is about supply side answers. [00:03:41] Speaker 1: But I was going to say, Gary Cohn was on our air on CNBC, I would say, in the last 24, 48 hours, and made this a similar point about maybe not having to touch the rate itself but having these other tools. I don't know if you think that's even plausible. [00:03:55] Speaker 2: I think that, I mean, the Fed has other tools. But as Joe's talking about, sort of the main tool that they have to effectuate interest rates in the economy is the Fed funds rate. And those other tools are both untested but also untested on the horizon that you're wanting to see rates come down. And remember, we haven't been anywhere close to the 2% inflation target essentially since the post-pandemic period. So, like, the Fed has had a lot of work to do, work that's been exacerbated by the choices that the administration has made that have been inflationary, like the tariffs. And I think it's sort of difficult to make the case that we're not in an environment where the question is, when will the Fed hike, not will the Fed hike? [00:04:33] Speaker 4: And Joe, the old Fed, what is the main criticism from the same people now that are resistant to raise rates? The criticism was that they waited too long and they're never going to get out from underneath that, the Powell Fed, for what happened. And I guarantee you, Warsh doesn't want to – he was probably one of the people – he was one of the people that it was very clear that they should have done something earlier. So he's not going to be in a position where he makes the same mistake. Right. [00:05:02] Speaker 3: No, of course not. I mean, look, Kevin was a Fed governor from 2006 to 2011. He's been kind of an institutionalist – I don't mean that in a bad way – but kind of traditional institutionalist in his approach. And that's not going to change now that he's got the job. I mean, yes, if you have a productivity boom and you see the labor costs plunge and inflation pressures moderate, absolutely, then he could hold things and wait. And I think the board will allow him to wait a meeting or two if he believes the inflation outlook, for whatever reason, is going to meaningfully improve. But beyond hiking the Fed funds rate – I mean, Joe, can you imagine if the Fed was going to try to sell some of his $2.5 trillion in mortgages? I mean, how disruptive that would be to markets and where long rates would go? If the Kevin Walsh-led Fed, which I believe will be a very good Fed, raises rates, you actually – in the short term, you actually may get long rates to actually fall. And that may actually – President Trump may like that, because those are the rates that matter most, are those long rates. [00:05:58] Speaker 4: We've seen – I've been mentioning that, and people have mentioned it to me, that sometimes when it seems like rates are headed higher, the long end – sometimes when it seems like they're not going to raise, that the long end rates go higher, when it seems like they're not going to – you would think that if you're going to cut rates, that rates would come down, and the – Well, you break-even rate. You get opposite effect on the long end. It's like, oh, they don't have the nerve to do what's necessary. [00:06:29] Speaker 3: If the Fed hikes and if the inflation risk premium comes – you know, collapses, you'll see lower long ends and interest rates come down. [00:06:37] Speaker 4: Yeah, yeah.