Wharton’s Jeremy Siegel calls for a 100 basis point rate hike and says markets could be “close to bottom”.
A 100 basis point interest rate hike by the Federal Reserve on Wednesday will be “medicine to stop this inflation,” the Wharton Professor of Finance at the University of Pennsylvania told CNBC on Wednesday.
“The Fed needs to pick up the narrative of inflation…they know it was way too late,” Siegel said in Squawk Box Asia.
“[You] I have to take your medicine now to be healed. If you just skip it, you’ll have to take more medication later.”
With annual inflation hitting a 40-year high of 8.6% in May, the likelihood of sharper aggressive rate hikes has sent markets reeling amid fears of a global recession.
US stocks plunged into the bear market earlier this week, sending ripples across global markets.
Jeremy Siegel
David Orrell | CNBC
Siegel said Fed Chair Jerome Powell could justify such an aggressive move by bringing forward the 50 basis point hike expected in July and combining it with the 50 basis point expected in June.
Anything less than a perceived firm move by the Fed this week will tell markets it’s not in control of inflation, Siegal said.
“If [Powell] only makes 50 [basis points], I think there will be a big disappointment. then [markets] will say he has no control, he’s not going fast enough,” he said.
The markets will recover
If the Fed nips the inflation problem in the bud, markets are likely to rally as investors and companies factor in higher interest rates and begin to downgrade earnings forecasts.
Rather than panicking and chasing more aggressive rate hikes after that 100-basis-point hike rolls out, the Fed should wait until it enters the economy, Siegel said. Too many aggressive moves could trigger a severe recession, he added.
In any case, the financial markets had already factored in a slight recession for 2023, he added.
“I think you’re going to get a rally, and [while] It’s very difficult to pinpoint exact market bottoms, I think we’re close to the bottom,” Siegel said, adding that the rally will die out within “hours” of the Fed’s announcement.
The Fed needs to pick up on the inflation narrative. You must now take your medicine to be healed. If you just let it go, you’ll need to take more medication later.
Jeremy Siegel
Finance Professor, Wharton
“And that would signal that we are taking the drug to stop this inflation. If we take it sooner, we’ll be better off later and there’ll be less chance of a recession in 2023,” he said.
If the Fed moves sharply on Wednesday, inflation should cool off by the end of the year and if commodity prices start to follow stock markets into bear territory, then the U.S. economy is on track to contain inflation, Siegel told CNBC .
But with the US economy bloated with stimulus — and if the Fed acts prudently — a wider recession can easily be averted, the professor said.
“There’s still too much liquidity, too low unemployment, too much demand,” he said.
“Unprecedented cash boost”
Excess liquidity and rising demand, driven mainly by government stimulus in the wake of the pandemic, are responsible for the price hike, although supply chain constraints also played a role, Siegel added.
“We have [an] unprecedented cash rush,” he said.
In the first half of 2020, as the pandemic peaked, a record $2 trillion surge in cash hit US bank deposit accounts — a reflection of the amount of cash sloshing around in the US economy.
In April 2020 alone, deposits grew by $865 billion, more than the previous all-year record.
“That was really at the core of the explosion in demand. Certainly we have Covid issues, we have the Russian invasion, I understand that,” Siegel said.
“But what the Fed should have done … is to say: [it] needed the first stimulus after Covid hit,” he said. “Then it should have told the government you need to go to the bond market… [it] can’t get a hand from the Fed.”
“Then interest rates would go up much earlier and we wouldn’t have the inflation problem we have now,” he added.
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