(Bloomberg) — Wall Street’s reaction to Tuesday’s consumer-price index shows investors are realizing inflation is likely to remain higher than the Federal Reserve’s goal for longer. Two heavyweight market voices say the 2% target is part of the problem.
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“Back in the day, they should’ve said 3% instead of 2%,” Kenneth Rogoff, a professor at Harvard University and former Fed economist, told Bloomberg Television Tuesday. “If you change it, it means you might change it again. Inflation they’re going to allow to be elevated for longer but they’re going to say it’s going to get back to 2%, it’s just taking longer. That will be the rhetoric.”
Equities whipsawed Tuesday after data showed the CPI at 6.4% in January from a year earlier, still far above the Fed’s goal despite months of interest rate increases. Following the report, a raft of Fed officials said the central bank may need to keep tightening to ensure inflation continues to fall.
Mohamed El-Erian, the chairman of Gramercy Funds and a Bloomberg Opinion columnist, also sees the Fed stuck with an inflation target that will be challenging to reach.
“It is very difficult to change a target when you have missed it for so long,” he also told Bloomberg Television Tuesday. “The minute you do that your credibility is hit even harder. If people sat down today they would not come up with 2%, they would come up with 3% to 4%.”
El-Erian sees inflation likely getting “stuck at 3% to 4% and the Fed keeps promising us 2% in the future and hopefully we learn to live with stable 3% to 4% inflation.”
Both Rogoff and El-Erian see higher rates for some time to come.
“When inflation comes down, don’t be sure interest rates are going to come down as much as people got used to before 2022,” Rogoff said. “The next decade we will land at a higher real interest rate than before.” The Fed will “have to figure out where do we put the interest rate long term so that we don’t have inflation.”
And, said Rogoff, “higher real rates will mean lower asset prices in general.”
While El-Erian cautioned market participants to “keep an open mind” on possible outcomes from relative economic strength and rising interest rates, “the most likely scenario — and I give it 50% — is that we end up with sticky inflation of 3% to 4%.”
The central bank’s peak for its overnight lending rate will be “higher than what the market has priced in,” El-Erian said. “We would stay there for a while.”
–With assistance from Lisa Abramowicz.
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