Former US Treasury Secretary Lawrence Summers said the surge in US jobs in September is "good news" for now, but it also shows the Federal Reserve's interest rate hikes are not working as well as before, increasing the danger of a hard landing for the economy.
Data on Friday showed U.S. employers added 336,000 jobs in September, nearly double economists' expectations, after upwardly revised payrolls in the previous two months, though the report also showed wage growth slowing.
"You have to recognise that these are good numbers, but I wouldn't say they guarantee a soft landing," Mr Summers said.
A year and a half ago, the Fed embarked on its most aggressive monetary tightening campaign in decades, raising interest rates by more than 5 percentage points. Summers said the performance of the US economy showed some fundamental shifts in the effectiveness of Fed policy.
"We may live in a world where interest rates are no longer the tool that they used to be to guide the economy," Mr Summers said. "That means when markets need to cool down, rates will have to be more volatile than in the past."
He also warned that given the current sell-off in the bond market, coupled with geopolitical risks and rising valuations in many markets, including private equity, "I'm seeing a much more severe financial crisis than I've seen in a long time." He urged policymakers to discuss "emergency measures to deal with the financial crisis".
As for why the U.S. economy might be less sensitive to interest rates, Summers noted that since many homeowners locked in lower mortgage rates in previous years, they are less likely to sell now. That reduces housing inventory, pushes up property values, makes people feel wealthier and helps sustain consumption.
Cause of change
Summers noted that higher interest rates also mean "more money in people's pockets." At the same time, some business investments, such as those in artificial intelligence, take less time to implement, making them less sensitive to interest rate levels.
Summers attributed half of the recent jump in Treasury yields to investors recognizing "what it's going to take to get the economy balanced" given the strong U.S. growth. He said the so-called neutral level of the Fed's benchmark interest rate, which neither stimulates nor slows economic growth, is now being raised.
The yield on the 10-year Treasury climbed as high as 4.89% after Friday's jobs data, its highest level since before the global financial crisis in 2007. That is about 1 percentage point higher than at the start of the year.
Summers said another key driver of the Treasury sell-off was the imbalance between supply and demand. The federal budget deficit will roughly double in fiscal 2023, forcing the Treasury to issue more debt.
"Significant impact"
At the same time, Summers stressed that foreign investors, including those from Japan, may have reduced their demand for U.S. government debt because of rising U.S. interest rates. In addition, the losses suffered by Silicon Valley banks on their holdings of US Treasuries in March this year have made US banks less willing to stockpile US Treasuries.
"So if you have more supply and less demand," Mr Summers said, then that "has to have a big impact on prices".
Given the current situation, Summers said, "I don't think rates are likely to fall as much" as markets expect. "I wouldn't be surprised if the market adjusts its expectations further."
He also criticised the Federal Reserve and the US Treasury for failing to take advantage of low interest rates to extend the maturity of public sector borrowing. While businesses and households are locking in low rates for longer, U.S. financial authorities are actually doing the opposite, he said.
QE legacy
Summers said the Fed's past policy of quantitative easing (QE) - injecting liquidity into the economy by buying trillions of dollars of Treasury bonds - meant higher borrowing costs for the public sector because the Fed paid higher short-term interest rates on the reserves created by QE.
"We are facing higher and higher debt," he said. "We have to have a serious discussion about the unsustainable fiscal policy path that has accumulated in many industrialised countries," he added, hoping that such talks could take place at the annual meetings of the International Monetary Fund and World Bank next week.