The Federal Reserve has decided to keep interest rates steady as Wall Street speculates about the possible outcomes of a higher-for-longer environment. Moody’s Analytics Chief Economist Mark Zandi joins The Morning Brief to discuss the Fed's policies and why the central bank should begin cutting rates now.

Zandi explains that the Fed's 2% inflation target is inappropriate at this moment: "If you were asking me de novo today without the legacy of that 2%, I'd say it should be closer to three. Just given that the underlying growth rate of the economy is slower than when the 2% target was put into place, but I think the Fed officials want to get back to two, establish credibility, make sure that they've done what they said they were going to do."

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This post was written by Nicholas Jacobino

Video Transcript

We want to bring in Mark Zandi, he's moody's analytics, chief economist joining us now, Mark, it's great to see you here.So you've been talking about the fact that the Fed should be really thinking about cutting soon.We are clearly starting to see weakness within the economy.I'm curious.So, from your perspective, if the Fed does not cut this summer, what does that then do for the odds of a recession?Uh Well, it'll, it'll increase them.Uh, you know, I think the economy is fine, it's resilient, it's doing well, but the interest rates are high and it's, uh, you know, those rates are like a corrosive on the economy.They wear the economy down and at some point, something could break.So the, the risks that they're taking here is that, uh, you know, uh they undermine the economy and recession occurs.But, you know, a long way from that sha uh uh I mean, I think the economy is, you know, generally resilient.Uh But I, I would, at this point, uh, you know, if I were king for the day, I'd be, uh really, uh cutting rates at this point because I do think the economy could use that relief mark.What happens though if it doesn't, if we don't see the fed cut when we talk about the risk here of something breaking in the economy, what does that then potentially look like?Well, uh you know, it could be a number of different places.I mean, the financial system is under a lot of pressure, the yield curve, you kind of forgotten about that, but it's still inverted, meaning short rates are higher than long, meaning the funding costs that banks and other financial institutions face is high relative to their lending rates.That's, you know, that's not really a good place to be for a bank, uh particularly when uh loan growth is soft because of the tightening and underwriting standards and regulatory costs are up because of the increased scrutiny, credit conditions are eroding.So, you know, uh the financial system is under a lot of pressure in, in that kind of environment.Uh that, that's, that would be a good case uh for something breaking.Uh you know, we got a taste of that a little over a year ago with the Silicon Valley Bank and uh and the bank runs.So, you know, we've experienced something uh like that.Uh But that's the kind of thing, I'm, I'm, I'm worried, read about in the context of uh persistently high interest rates.So all these things considered, Mark.Uh what are you gonna be listening for in the tone of the Fed.I mean, we've had a bunch of Fed speak already this week and we're gonna, we're gonna end this week with even more Fed speak, uh, tomorrow and one more speaker later today, what have you made an aggregate of what they have to say about their read on the economy thus far?Well, uh, they're taking a different position than I am.I, I mean, I, I, they clearly realize that these rates are high and that they're putting pressure on the economy, but uh they are more focused on making sure that inflation is back to their 2% target.Uh And uh you know, by the measure that they're focused on the core, excluding food and energy consumer expenditure, fl uh we're not there yet.So they, they want to get there.Uh So I don't think at this point it's really about the data less about what the fed officials are saying they made it pretty clear that they're not going to cut rates until uh inflation by that measures at two.And so that's going to take at least a couple three months of data that would square with that forecast before they start cutting rates.So I expect they're going to just stick to that message and you know, keep pounding it until the inflation data as they are focused on comes in mark.Should it be that 2% target?No.Uh you know, if I, if, if you were asking me De Novo today without the legacy of that 2% I'd say it should be closer to three.Just given that the underlying growth rate of the economy is slower than when the 2% target was put into place.Uh But, you know, uh, I, I think the, the fed wants, the fed officials want to get back to, to establish credibility, re make sure that they're, you know, they, they've done what they said they were going to do and then once they get that 2% then I think they'll take an opportunity to change the framework for conducting monetary policy.And I don't think they're gonna pick a number per se, but they're gonna, uh and I'm not sure exactly how they'll, you know, do this, but they'll figure out a way to provide, give them a little bit more flexibility.They'll, next time around they won't have to get down to that too.Just a quick point of interest.If you have a 2% target uh on inflation, uh given the underlying growth rates in the economy and given the typical amount of interest rate cutting the Fed does during recessions in a typical recession, we're always gonna hit the zero lower bound, meaning the fed is always gonna bring interest rates down to zero and then have to quantitative ease and that's something they really don't want to do.So that's why we uh two is not the right number, probably something closer to three would make more sense is the fed once again facing a credibility risk.I mean, transitory for, for too long.And, and then now we're staying in the higher, for longer conversation for perhaps longer than we would have anticipated at this juncture, at, when we were coming into the year looking for several rate cuts and now that's cut down to one, maybe two.Well, I think they think their thought process is they're, they're ensuring their credibility like they say, hey, look, we're gonna hit 2%.We're not, we're not cutting rates until we're at 2%.Uh And uh we're confident that we're going to be there.Uh And so that's what they're desperately trying to establish here that uh they, they, they do what they say they're gonna do.Uh You know, even though they're taking up an increasing risk that, that, that policy will break something in the financial system or the broader economy in the, in the liberal markets or somewhere else.And we, we land ourselves into recessions, but they're desperately trying to uh re-establish that credibility.All right, Mark Zandi Moody's analytics.Chief economist.Thanks so much for taking the time.Always a pleasure to speak with you.Mark any, any time, take care