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Fed hiking rates by 75 basis points ‘the right move’ amid inflation, economist says

Jefferies Money Market Economist Tom Simons joins Yahoo Finance Live to discuss the state of the economy, inflation, the possibility of a 75 basis point rate hike, and the outlook for the Fed ahead of the FOMC meeting.

Video Transcript

BRIAN CHEUNG: Markets are now overwhelmingly expecting a 75-basis point move, or 0.75%, from the Federal Reserve at the conclusion of their meeting tomorrow afternoon. That would be the most aggressive rate increase from a single meeting since 1994. Joining us to break it all down is Tom Simons, Jefferies Money Market Economist. It's great to have you on the program, Tom.

I wanted to ask you-- I mean, you were among the first on the street to actually call for the Fed to make a 75-basis point move after that inflation report last week. After the "Wall Street Journal" report yesterday, just kind of curious to hear your thoughts about how markets digested the conclusion that, essentially, this is what we're going to get tomorrow afternoon.

TOM SIMONS: Yes. So I think the markets, actually, are pretty receptive to it. At this point, given the sort of gravity of the situation with inflation as it is now, even though it's kind of a surprise relative to what we've heard from the Fed in terms of what they said they were going to do, it looks like it's the right move.

So I think that the markets are going to feel more confident about the Fed's credibility in terms of their ability to limit inflation. And overall, it's going to lead to a better positive outcome for the economy in the long run.

AKIKO FUJITA: Tom, let's back up a bit to Friday. To Brian's point, you were the first out of the gate to call for a 75-basis point hike. You pegged that to the data that we got on Friday-- CPI, as well as what we got out of the University of Michigan. Walk me through that what. Fundamentally changed?

TOM SIMONS: Sure. So if it were just the CPI in isolation, I don't think that it would have necessarily been a good idea to sort of throw out all the forward guidance that we got from the Fed about a 50-basis point rate hike. But, really, it was the University of Michigan that put it over the top. That long-term inflation expectations survey showed that inflation expectations rose to 3.3% from 3.0%.

That may not sound like it's a huge move in the grand scheme of things, but that index generally doesn't move very much at all. And the Fed's whole inflation targeting framework for policy is based on stable inflation expectations at its foundation. So once that starts to sort of look a little bit weaker, a little shakier, it really is imperative on the Fed to get their hands around inflation as fast as possible and show a stronger resolve towards actually fighting against it. And I think that the best way they could possibly do it at this point is to go with a more aggressive rate hike versus what they said they were going to do only a few weeks ago.

BRIAN CHEUNG: So, Tom, I've been refreshing the Fed funds futures to see if 100 basis points pops up in the probability. But, look, you have former New York Fed President Bill Dudley saying this morning there could be an argument for 100 basis points. You have ING saying there's an implied probability that could pop up on 100 basis points. You see that as an option tomorrow?

TOM SIMONS: I think that it's probably unlikely, just because 100 is very aggressive. And you don't want to have the Fed continually trying to one-up expectations on the market, because that eventually leads to problems with communications down the road. I think that there is a very, very strong argument for getting the Fed funds rate up to a neutral level as fast as possible.

And the Fed has said this, essentially, by saying they want to get there expeditiously over the last few months. Certainly, 100 basis points would help speed up that process. And I think that there is some validity to it. But I also think that the market last Thursday was not pricing in a 75-basis point rate hike for this meeting.

So it takes some time for these things to become ingrained in expectations. And I think it's probably better that they just follow through with 75 here tomorrow.

AKIKO FUJITA: Tom, when we talk about getting inflation under control, I mean, there is a long list of things that the Fed cannot control-- whether it's Russia-Ukraine, whether it's supply chain issues, another potential lockdown in China related to COVID. To what extent-- or how effective can a 75-basis point hike be?

TOM SIMONS: I think that it's going to be most effective in its translation to inflation expectations rather than realized inflation in the short-term. As you mentioned, there's a number of different bottlenecks that are affecting the economy, mostly on the goods side, but also on the services side as well. Generally, it isn't so much like shipping delays and product shortages, it's labor market shortages that affect the service side.

That isn't really going to be resolved by one 75-basis point hike or even a series of hikes here in the next few months. However, again, you know, it's really on the expectation side, when we think about how the Fed is going to be fighting inflation for the next several years, if they start to see inflation expectations run away from them, that's a process that could take decades for them to get their hands back around.

It really was basically Paul Volcker in the 1980s with very aggressive rate hikes that established that Fed credibility to fight inflation. It held very, very strongly all through the '80s, and '90s, and the 2000s, up until now. And it's only now that it's being called into question. So in the future, it's going to be very, very important that is maintained, for sure.

BRIAN CHEUNG: And, lastly here, what would you ask Jay Powell in tomorrow's press conference? What do you want to know?

TOM SIMONS: That's a great question. Why did you take a second term? Are you regretting it? No, I don't really have a whole lot of questions for him, to be honest. I think that he has the resolve to go against the market expectations that were in place only very recently.

And I think he knows what his job is. And I think that he knows it is absolutely imperative that they don't lose control of inflation expectations. So I would just ask him, do you agree with that, I suppose.

AKIKO FUJITA: Well, Tom, you have set Brian up for his question at the press conference--

BRIAN CHEUNG: About his second term, definitely.

AKIKO FUJITA: Why did you take a second term?

TOM SIMONS: Don't do that one.

BRIAN CHEUNG: No.

TOM SIMONS: Don't do that one.

AKIKO FUJITA: Tom, it's good to have you on today. Tom Simons, Jefferies Money Market Economist, appreciate the time.