‘I’m disappointed’ Fed didn’t raise rates by 125 basis points, Komal Sri-Kumar says

Sri-Kumar Global Strategies, Inc. President & Founder Komal Sri-Kumar joins Yahoo Finance Live to discuss Federal Reserve policy, the central bank's fight against inflation, the strengthened dollar and other currency moves, as well as the outlook for global economies.

Video transcript

[AUDIO LOGO]

INES FERRE: And to continue the market conversation, let's bring in Komal Sri-Kumar, President and Founder of Sri-Kumar Global Strategies. Komal, thank you so much for joining us. You had-- you had wanted the Fed to have a-- to increase rates by 125 basis points. Tell us, were you disappointed that the Fed did not raise rates by 125 basis points? And do you think that in the next meeting, they should? And why?

KOMAL SRI-KUMAR: You have several questions there. Let me start going one after the other. Yes, I am disappointed they did not raise by 125 basis points at the last meeting. I did not really expect them to because, in my mind, this is a relatively dovish Fed. So I had banked on about 75 basis points, which is what I got.

The advantage of 125 basis points would have been that that would have put the Fed way ahead of the market, ahead of the curve, and thereafter, they will not have to do very much. This way around, they increased it by 75. The market is expecting another 75 in November. And the market will keep expecting that for a few more meetings. So in other words, by going so gradually, they are going to increase even more than they would have had they given one big move last month.

AKIKO FUJITA: Sri, with that said, we were just talking about the comments that we got from Chicago Fed President Charles Evans today about the concerns that many others have raised about moving too aggressively and too soon. Obviously, you weren't anticipating 125 basis points. That's what you said they should be doing. But how big of--

KOMAL SRI-KUMAR: Exactly.

AKIKO FUJITA: --a risk is that factor in terms of going too quickly when we haven't necessarily seen the Fed policy, or at least the intended impact of it, take hold yet?

KOMAL SRI-KUMAR: The question is what we all mean by risk there, Akiko. And if you are talking about the risk of a recession, that risk is clearly dead. There is nothing the Fed can do about it. They should have thought about it last year, in 2021.

When they were calling the inflation transitory, I wrote every month, every possible opportunity that they are totally wrong-- Jerome Powell was out to lunch-- and this inflation was going to be high and sustained. Having made a mistake there, having kept interest rates very low for too long a period of time, and even after he decided last November that inflation was not transitory, recall that the Fed did not start tightening until March of this year. Why did they wait another four or five months?

They've made the situation much worse. They are talking about home prices, and Secretary of Treasury Janet Yellen was talking about high home prices putting them beyond the reach of first-time buyers. At the same time, the Federal Reserve was pushing up home prices by buying agency mortgage-backed securities. It is just incomprehensible to me.

Do they have a big risk? Yes. Will there be a recession? Yes. It will also be a stagflation because we are going to have a combination of recession with persistent high inflation rates like we did not see in the 1970s. So there is nothing the Fed can do. They can't reverse policy. If they want, they can go back in the time machine and probably go back 15 months and change the picture.

INES FERRE: Sri, can you give us a sense of what the impacts of these rate hikes will have on institutions, on companies that are loaded with debt? I mean, the government has so much debt. It is such a different environment than the Paul Volcker environment, Paul Volcker being the Fed chairman that Chairman Powell has referenced so many times.

KOMAL SRI-KUMAR: You are absolutely correct. There is a lot more debt today than we had in the 1970s. And that's going to make the situation much more difficult to handle, both for the US Treasury and for large corporations. What I think that would lead to is the fact that with the passage of time, you're going to have one or a few large companies which are unable to service obligations. And that, in turn, is going to cause what we say, quote unquote, "credit event," meaning somebody cannot repay the debt. They default. And that, in turn, causes the Fed to switch.

So if you are looking for interest rate increases to come to an end or to slow down, one way to do it is to have a credit event and the Fed reacts to it by saying now our job is to save the system. Think about 1998 with the long-term capital management which unexpectedly collapsed in the aftermath of higher interest rates earlier in the decade. Think about 2008 when Lehman Brothers went down. And in each case, the monetary policy shifted to easing. And that is one of my scenarios as a possibility for the future.

Another scenario would be that the very strong dollar, in turn, causes new issues of its own because the strong dollar leads to-- typically leads to financing issues. And if that happens, and if you have a coordinated manner of supporting the dollar, like we did with the Plaza Accord in 1985, that will be a turnaround in policy as well. So you need accidents to change it. You're not-- it's not going to happen with the normal course of time.

AKIKO FUJITA: Finally, Sri, well, we're talking about the Fed right now. Obviously, we're in a global higher rate environment, a lot of focus being placed on the Bank of England given what has played out over the last few days, the huge swing that we've seen in the pound, also on the back of these tax cuts that have been proposed by this new administration. Where do you think the BOE moves from here? And what is the risk of contagion of a misstep spilling across borders?

KOMAL SRI-KUMAR: Your first question first, what do I think the Bank of England is going to do? They have already told us they are not going to do anything before the November meeting. And that is way too late. So what I expect is that you will, again, even though today is a day of relative peace, both for the pound sterling as well as for UK bond yields, this peace is not going to last. This calm is not going to last too long.

We are going to have one more turbulent move, if not more. And I am expecting an emergency rate hike on the part of the Bank of England. The risk of doing that is the following. If they raise interest rates by 100, 150 basis points, that, in turn, has to work to support the pound. But more often than not in various countries, especially in developing economies, it gives rise to a new run on the currency.

So people decide the government is very concerned about it. They are going to increase interest rates. So rather than buy pound sterling, I'm going to sell them. So that, I think, is what is the big risk. In terms of the policy itself, Akiko, I think the Bank of England and the chancellor of the exchequer have been working at cross-purposes with each other. You almost wonder whether they belong to the same government or not.

Earlier in the week, the Bank of England increased the interest rates by 50 basis points. And on Friday, the chancellor of the exchequer offset that with huge tax cuts. You cannot have one entity trying to cut aggregate demand when the other entity is trying to increase it.

That's going to end up in mass confusion, and that's what we saw take place Friday. And over the weekend, the chancellor talked about further increases in terms of fiscal stimulus, possibly cutting taxes further. And you saw what happened yesterday. We had a renewed fall in the pound. So that's where we are.

AKIKO FUJITA: Translation-- more volatility to come.

KOMAL SRI-KUMAR: More volatility, that's right.

AKIKO FUJITA: Komal Sri-Kumar, President and Founder of Sri-Kumar Global Strategies. Appreciate your time. Good to have you on today.