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Powell misunderstands what drives the US economy, says a former Fed official

By Greg Robb

Fed chief underestimates how much loose financial conditions are boosting economy, says former New York Fed president

Federal Reserve Chairman Jerome Powell is misinterpreting a source of strength for the U.S. economy, a former senior Fed official said Thursday.

Powell argued in a speech on Wednesday that the reason the U.S. economy has been stronger than expected for more than a year is the normalization of supply chains. Removing the roadblocks will give the economy a once-in-a-lifetime boost.

In Powell's view, interest rates are high or restrictive enough to curb demand and reduce inflation. The Fed's key interest rate is in a range of 5.25% to 5.5%.

It is about the so-called “neutral interest rate”, where interest rates would apply if the economy grew at around 2% and the inflation rate was 2%.

Last month, the Fed slightly revised its estimate of the neutral interest rate from 2.5% to 2.6%.

In an interview with Bloomberg Television, former New York Fed President Bill Dudley said he believes the Fed estimate is still well below neutral.

Dudley said he expects the neutral rate could be as high as 4%, where it was before the 2008 financial crisis.

One sign that rates are not tight is the fact that financial conditions have eased since October. Dudley said Powell overlooked how this easing was boosting growth.

“I think what he underestimates is the fact that financial conditions have eased significantly since October and that is providing significant support to the economy,” Dudley said.

In the interview, Dudley said that this underestimation will not necessarily impact the short-term view of Fed policy. The central bank's forecast of three rate cuts this year remains “within the realm of possibility,” he said.

The important difference is that the Fed believes it will stop cutting rates, he said.

The Fed now predicts it will gradually cut interest rates to 3.1% in 2026.

According to the CME FedWatch tool, the market has revised up its forecast that the Fed will end the rate cut to 3.75%.

“This time the market is right,” Dudley said. That view has driven up the 10-year Treasury yield recently, he said.

-Greg Robb

This content was created by MarketWatch, operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

04-04-24 1155ET

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