Top economist says central bank has been too conservative with its policy
Public debate about potential inactivity from the Federal Reserve this week has been intense, with the Trump Administration criticizing the projected inaction. Now, you can add the voice of a major economist to those believing the Fed is being too conservative with its policy.
Lawrence Yun (pictured top), chief economist and senior vice president of research with the National Association of Realtors (NAR), believes the Federal Reserve is too focused on the potential impacts of tariffs, causing it to keep rates too elevated.
I believe that the Federal Reserve is a little step below, a step behind,” Yun told Mortgage Professional America. “And the reason I say that is that the Federal Reserve, as they are projecting about the policy based on future inflation, they're so focused on tariff impact. What's going to happen to tariffs, and how is that going to impact prices? That's all the discussion.”
Yun believes the Fed should consider other factors besides the potential impact of tariffs.
“The Federal Reserve is not looking at other factors that could potentially reduce inflationary pressure,” Yun said. “Things like deregulation, low oil prices and also how the shelter cost component is decelerating quite sizeably. The Federal Reserve is not talking about or focusing on this other disinflationary pressure. They're only focused on one thing, tariffs.”
Economic turmoil surrounding the Trump administration’s tariffs has caused concerns about increasing inflation. However, Yun notes that other factors impact inflation besides tariffs.
“Once you look at other potential factors impacting inflation, things like lower oil prices and less regulation,” he said. “And also, the shelter cost component of inflation is coming down. That's implying that inflation looks to be definitively calmer by summertime. And with that in mind, the Federal Reserve may begin to say, tariffs are one thing, but there are other disinflationary pressures coming from it.
“This sort of signaling could make the market anticipation of the next rate cut to be little sooner rather than later.”
6 rate cuts needed to get to normal
Yun hopes the Federal Reserve will note that it’s considering factors beyond tariffs when issuing guidance at this week’s meeting. Like most experts, he does not anticipate any rate cuts.
“It’s not going to be (this) week, but I wish the Federal Reserve to be more vocal in their commentary,” Yun said. “To say they're looking at the tariff, they're looking at other factors that influence inflation.”
If there is an indication that the Fed is considering more factors in their analysis, Yun hopes that might guide them to cut rates sooner than expected.
“As they widen the number of factors they're looking at, I think that will give a little comfort to the market, that the Federal Reserve will be more inclined to cut interest rates sooner,” he said. “Meaning that, rather than in September, maybe it's a meeting before that, or definitely by September.”
The other factor is that the Fed funds rate remains higher than historical levels. While other countries have cut rates, the Fed has held steady. Yun believes it would take a series of cuts over the next year to get the funds rate back to a normal level.
“Right now, the Fed funds rate is, by historical standards, very elevated,” Yun said. “To just get to the historical average, one is looking at possibly six rounds of rate cuts over the next, say, 12 months.”
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Despite the likely lack of movement from the Fed this week, Yun is hopeful that the market will still see a break in interest rates in the second half of the year, even if he admits it has been challenging to pin down a forecast because of the Fed’s conservative stance.
“So I think by the end of the year, you will be something in the sixes,” he said. “I've been a little bit off on this figure with the Fed delaying rate cuts. But I think rates will be from 6% to 6.5%. I think that will be what consumers should expect by the end of the year.”
Impact of geopolitical turmoil on bond, treasury markets
Yun believes the elevated rates aren’t completely due to the lack of cuts from the Federal Reserve. Bond yields have also helped to keep rates higher.
“It's really about the bond yields,” Yun said. “The national debt being high doesn't help on the bond yields. But when the Fed cut the interest rate back in September of last year, it did not do anything to the mortgage rate. In fact, the mortgage rate actually crept up even as the Fed was cutting rates.”
Like the Federal Reserve, Yun expects improvements in the bond market when investors are sure that inflation is completely under control.
“What the bond market is looking for is assurance that the inflation is fully contained,” he said. “In September of last year, it potentially could be contained, but it was not a certainty. So, the next Fed rate cut, which I think is the second half of this year, the reasoning for the rate cut will be that inflation is fully under control, and that will bring the bond yield down.
“So once there is more data evidence that inflation is clearly getting under control, and therefore the Fed cuts interest rates, the bond yields will immediately follow the path of the Fed policy.”
With the new turmoil in the Middle East, there have been questions about what that might do to treasury bonds. Yun believes investors will look for the safety of the US market in times of turmoil, which could lower bond yields as well.
“And related to other uncertain geopolitical matters, at least related to the bond market, if anything, it is going to lead more money into the US Treasury bonds,” Yun said. “And American consumers, they're so far removed from what's happening on the other side of the globe that they're just looking at, they have a job. Mortgage rates are high, but if the mortgage rate goes down, and if they qualify for a mortgage, I think they will start searching for a home.
“So, if anything, that geopolitical uncertainty may ease down some of the bond yields.”
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