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The Fed is in a 'sweet spot' to bring rates back to neutral, says former governor

Key Points
  • The Federal Reserve is in a sweet spot to bring interest rates in the U.S. back to neutral levels, and may need to continue raising rates for another two or three times, former Fed Governor Robert Heller said.
  • His comment came after the central bank raised its benchmark interest rates by 25 basis points on Wednesday.
  • U.S. stocks sank even though the Fed lowered its projection for interest rates increases in 2019 to two from three.
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'The Fed is really in a sweet spot right now'

The Federal Reserve is well positioned to bring interest rates in the U.S. back to neutral levels, and it may need to raise rates two or three more times, former Fed Governor Robert Heller said.

The Fed on Wednesday raised its benchmark interest rates by 25 basis points — its fourth hike in 2018 and the ninth since December 2015 when it started rolling back post-crisis stimulus. The central bank projected it would enact two interest rates increases in 2019, which was down from a previous forecast of three, but that wasn't enough to appease investors who had hoped the Fed would ease even further off its tightening path.

But for Heller, who said he favors "even tighter policy," the Fed did exactly what it had to.

"The Fed is really in a sweet spot right now: Growth is good, unemployment is very low at 3.7 percent and they're roughly at their target of 2 percent inflation. So, what could be better?" Heller told CNBC's "Squawk Box" on Thursday.

"They have to continue on their path of taking away the accommodation and get into a neutral stance and that's exactly what they did," he added.

Heller was a member of the Fed's Board of Governors from 1986 until 1989.

VIDEO1:5501:55
Wall Street's strong asset prices could be dangerous

U.S. stocks sank after the Fed decision on Wednesday. Wall Street has had a wild ride in the last few months amid growing worries of a global economic slowdown — which U.S. President Donald Trump has blamed in part on the Fed hiking rates.

"I think the market got what it expected and that was a 25 basis points increase, but did not get what it hoped," John Petrides, managing director and portfolio manager at Point View Wealth Management, told CNBC's "Squawk Box" on Thursday.

Petrides said investors may have been disappointed because, just last month, Fed Chair Jerome Powell said he considered the central bank's benchmark interest rate to be near its neutral level — the point where monetary policy is neither speeding up nor slowing down the economy.

Many took that comment as a sign that the Fed could be near the end of its tightening cycle, but were let down when Powell's latest remarks on Wednesday indicated that the central bank still intends to raise rates, Petrides noted.

A looser monetary policy stance — where interest rates are low and money supply is higher — is generally more favorable for stocks. That's because such a policy helps to increase economic activity by encouraging more companies and individuals to lend, spend and invest in the private sector.

But Heller noted that even with the latest hike in interest rates, the Fed's monetary policy is still accommodative overall.

"The Fed funds rate is, at the present time, not neutral but it's accommodative. And what they have to do is to get back to neutral so they have slowly been raising their rates ... and they have to do that for maybe another two or three hikes," the former governor said.

WATCH: Why markets are still disappointed by the Fed's rate hike
VIDEO1:5601:56
Why markets are still disappointed by the Fed's rate hike