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Roubini: The Fed is 'cornered'; will either lose control of inflation or crash markets

Kitco News

(Kitco News) - While inflationary fears are picking up, the markets have not demonstrated a readiness to accept higher interest rates. In fact, rising nominal treasury yields over the past few months have, on several occasions, prompted market selloffs.

This predicament puts the Federal Reserve in a tough position, said Nouriel Roubini, CEO of Roubini Macro Associates and professor at the NYU Stern School of Business, because should the Fed raise interest rates to try to control inflation, the market may see a return of 2013's "taper tantrum".

"Either the Fed, at that point, keeps on saying things are temporary, inflation expectations start to rise, they control the short end of the yield curve, but then long rates can rise in nominal and real terms, that's one risk. Then, inflation gets out of control. Or, like in 2013, they have to backpedal and say no, there is a problem with inflation and we have to start tapering sooner than we said, we need to start raising rates sooner than we said, and we could have a repeat of what happened in 2013," Roubini told Michelle Makori, Kitco's editor-in-chief.

In 2013, when the Fed announced a reduction in its pace of Treasury bond purchases, U.S. Treasury yields soared on the announcement.

A repeat of this scenario could have serious implications for all markets, if not the broader economy, Roubini said, noting that the fixed income sector is particularly at risk.

"So either way is risky. Either you're behind the curve, you're going to cause inflation, or if you don't want to be any more behind the curve, and then you signal, 'I'm going to tighten', then you could have a bond market and a credit market crash that could really weaken the economy, if not stall it. It's damned if you do, damned if you don't," he said.

On inflation expectations, Roubini agreed with Treasury Secretary Janet Yellen's assessment that interest rates would have to rise to prevent inflation from "overheating."

Yellen made this statement at an economic event hosted by the Atlantic magazine earlier this week, but quickly retracted her statement after markets tumbled by saying that she doesn"t think inflation will be a significant problem.

"I think that she was telling the truth when she expressed her own first concern that maybe there could be overheating that might lead to inflation to overshoot what the Fed does, therefore the Fed [will have] to raise rates," Roubini said.

For more details, including what Nouriel Roubini thinks about central bank independence and the Biden Administration's spending, click the link and watch the video above.

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