Larry Summers, the former U.S. Treasury secretary, is “not optimistic” about the outlook for inflation coming down in the near term.
Summers, who correctly forecast that U.S. inflation would rise sharply following the monetary and fiscal stimulus enacted during the pandemic, said forecasting inflation levels going forward will be much harder and he doesn’t see it falling without a recession. “My core read is not that optimistic,” he said at the Morningstar Investment Conference in Chicago on Wednesday.
“I think we’re going to have difficulty getting near a 2% inflation target until and unless the economy slows down substantially,” he said.
The most recent inflation reading for March showed that prices rose 5% from a year earlier.
Summers, a Harvard University professor, said another recession wouldn’t necessarily be as severe as the ones caused by the Covid-19 pandemic, the 2008 global financial crisis and 1982’s recession—when unemployment reacted 10%. But any recession hurts.
Recalling the experience of President George H.W. Bush in 1992, Summers said, “even fairly limited recessions have a significant effect on the national mood.”
Summers also thinks current stock market prices are fully valued and that the market isn’t pricing in a recession. While he doesn’t advocate market timing, he also urged investors to be careful in equity markets, saying that the consensus view is for a recession, but that forecast corporate earnings for most large-cap companies “don't seem to be building in what would be the likely consequence of a substantial recession.”
He also sees a disconnect between stock and bond markets. Stock markets aren’t pricing in a recession, yet federal fund futures and the U.S. Treasury bill yield curve suggest that the Fed may embark on six or seven rate cuts in the next two years.
“I don't think we'll have six or seven rate cuts unless the economy is in a recession,” Summers said, later adding, “I think there's an important kind of disjunction between what's being said in equity markets, and what's being said in fixed-income markets. And of course, that kind of disjunction creates possible opportunity.”
What he is not worried about is a fiscal cliff, saying that the odds of a government default are “under 2%.”
As for economic data, he told the audience to watch Friday’s quarterly employment cost index figure to get a read on what’s happening with wage inflation and underlying costs, calling it the quarter’s most important data. He said this report is more accurate than the hourly earnings data included in the monthly unemployment report, since the employment cost index figure adjusts for the composition of the labor force.
Looking ahead to the coming Federal Reserve meeting, Summers said the right thing for the Fed to do at next week’s policy meeting is to raise rates by 25 basis points. He reiterated his view that the Fed has lost credibility because it was “behind the curve” on fighting inflation. The Fed has a tendency for “groupthink,” he said, though he also cut the central bankers some slack.
“In fairness to the Fed on inflation, most people on the outside were probably closer to [the Fed’s] view on inflation than my view on inflation, so in some ways they tracked a consensus. You can argue that’s what they should do. In fairness to the Fed, it’s not like every stock analyst had a sell recommendation on [Silicon Valley Bank], even though most of the information was public,” Summers said.