US Fed readies for biggest rate rise in 28 years

JPMorgan Funds chief global strategist David Kelly and research analyst Stephanie Aliaga have argued the actions are aggressive and the Fed will have to soften its approach.

“Such aggressive action would likely be a mistake,” they said in a note to clients.

“While inflation won’t die out quickly without a recession, it should gradually drift down. If this is the case, the Federal Reserve should have the patience to let it do so, rather than try to speed its decline at the risk of tipping the economy into recession.”

First-quarter GDP in the US contracted by 0.35 per cent, surprising most forecasters. But a trade imbalance was largely responsible, because of an 18 per cent surge in imports. Consumer and business spending kept rising.

Mr Kelly and Ms Aliaga said a resolution of some supply chain issues and softer-than-expected wage growth should take some heat out of demand and, therefore, inflation.

They noted that trade union membership in the US continues to decline, and some wage bargaining power could be lost in fewer unionized workforces, taking some heat out of wage growth.

However, in the opposing camp at Goldman Sachs, chief economist Jan Hatzius estimates there is still a shortage of labour. Consequently, wages will keep rising, adding to inflation and keeping the Fed as hawkish as ever.

Mr Hatzius now thinks the Fed could raise rates beyond 3.25 per cent.

“In order to reduce wage pressure to levels at least broadly consistent with the Fed’s inflation target, we estimate that the jobs to workers gap needs to shrink by at least one-half percentage point,” he said.

“We further estimate that this means GDP growth may need to slow to the 1-1.5 per cent range, even weaker than our below-consensus 2022 forecast of 1.9 per cent.

“This will probably require a significant tightening in financial conditions from current levels, and it could well mean a higher terminal funds rate than our baseline forecast of 3-3.25 per cent.”

Deutsche Bank’s global economists David Folkerts-Landau and Peter Hooper expect the Fed funds rate to peak above 3.5 per cent next year, even higher than Goldman Sachs’ forecast.

They also expect the Fed’s quantitative tightening – or balance sheet rundown where it stops buying bonds – will add at least another 75 basis points worth of equivalent rate increases.

Such aggressive monetary policy will result in a technical recession next northern winter, before inflation recedes and the Fed reverses some of its rate hikes.

“We acknowledge huge uncertainty around these forecasts, but also note that the risks to the downside and of a deeper downturn are considerable,” said the Deutsche Bank economists.

Considering that just six months ago few thought the Fed would raise rates this year, it is easy to see why economists add such disclaimers to their forecasts.

Leave a Comment