Ex-Treasury chief Larry Summers sees interest rates peaking above 5% - and says markets have priced in most of this hiking cycle

Larry Summers
Larry Summers.
  •  Larry Summers expects the Federal Reserve to keep raising interest rates to north of 5%.
  • A surge in inflation expectations means markets are largely pricing in further rate hikes, he said.
  • The ex-Treasury chief has warned inflation poses a graver threat to the US economy than painful rate hikes.

Larry Summers has warned that US interest rates will probably peak above 5%, and he suggested the market has mostly priced in the hikes ahead from the Federal Reserve.

"The terminal rate, according to Fed funds futures, has just risen above 5," he tweeted Thursday. "This is a kind of milestone."

"I think it is more likely than not to rise more," he continued. "But the increase already of more than 400bps in 18 month is surely most of the increase we will see in this cycle."

Summers is a Harvard economics professor, a former Treasury secretary, and an ex-director of the National Economic Council. Based on his tweet, he only sees rate expectations climbing a little more, as they've already soared from under 1% in the spring of 2021 to over 5% today.

The Federal Reserve has hiked rates from virtually zero in March to a range of 3% and 3.25% today, and penciled in a terminal rate as high as 4.9% next year. While Summers expects rates to rise above that level, investors will likely welcome his view that market expectations are about right now.

The US central bank is raising rates to cool inflation, which surged to a 40-year high of 9.1% in June, and remained above 8% in September. Higher interest rates make borrowing more expensive and encourage saving over spending or investing. They may relieve upward pressure on prices, but can also weaken economic growth and increase unemployment.

Summers has been ringing the inflation alarm for a while, and urging the Fed to keep hiking rates as he believes backing down would be disastrous.

For example, he's flagged the high level of core inflation, the surging cost of housing materials, and the large wage bumps for workers switching jobs as signs of embedded price increases in the US economy.

He's also pointed to Russia's invasion of Ukraine as a significant inflation risk, given the conflict has disrupted global supply chains and driven up the price of food, fuel, and various commodities this year.

At the same time, Summers has warned that many people aren't fully grasping the economic fallout from the Fed hiking rates to 5%. Unemployment could surge from 3.5% to over 6%, representing millions of jobs lost, he said.

Still, he emphasized that if the Fed doesn't tackle the inflation threat now, it risks having to raise rates even higher in the future. It could also plunge the US economy into a stagflation that sends shockwaves across the globe.

Read more: 'It's difficult to be optimistic': A UBS real estate head shared just how much downside US home prices have in his 2023 housing market outlook

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