Fed to lift rates in 2016 more than markets price in, Posen says

[LONDON] The Federal Reserve will raise interest rates more this year than investors currently are pricing in, according to Peterson Institute for International Economics President Adam Posen, a former Bank of England policy maker.

"You should trust the Fed, not the markets," Posen told Tom Keene and Francine Lacqua on Bloomberg Television on Tuesday. "I think the market is under-pricing the likelihood of both a March rise and the number of rises in the year to come."

The US central bank last month raised rates for the first time since 2006 and said it expected the pace of future tightening to be gradual. Policy makers projected the benchmark interest rate would end 2016 at 1.375 per cent, implying four quarter-point increases in the target this year, based on the median from 17 officials. According to Fed funds futures, traders price in two hikes to 0.75 per cent-1 per cent during 2016.

With US unemployment falling, Fed Vice Chairman Stanley Fischer said last week that policy makers' forecasts predicting four interest-rate increases in 2016 were "in the ballpark," while San Francisco Fed President John Williams said a couple of days later that officials could raise borrowing costs more or less than four times this year. The Federal Open Market Committee is scheduled to meet next on Jan. 26-27.

The fact that Fischer and Williams both "talk about multiple hikes, for them to reverse that you would need a lot more bad news than we're seeing, and what you're seeing from the labor market isn't bad news," Posen said.

A key factor in the speed of interest rate rises will be productivity. As of December it had slumped, averaging just 0.5 per cent over the previous four quarters on a year-over-year measure.

"I'm much more worried about productivity now than I was a few years ago," Posen said. Weak productivity growth may boost the case for higher borrowing costs if it causes the economy to be unable to grow without creating inflationary pressures, he said.

"If you accept that we're going to have this domestic wage push, which is the assumption they're making, the fact of a productivity slowdown actually makes you more likely to want to raise rates," Posen said. "So if you're a productivity bear, you're a Fed hawk." Later, in an interview with Bloomberg Radio, Posen said he thinks the Fed will have to "stop ahead of their planned path" for increases because of an over-estimation of a pickup in inflation and a possibly slowing US economy.

BLOOMBERG