The United States is currently experiencing the worst inflation in history. As a result, the Federal Reserve was forced to take extreme measures to rein in prices, which policymakers deliberately dragged into a deep recession.
On Friday, Bank of America strategists said market prices suggest inflation will fall to or below the Fed’s 2% target over the next two years. However, this requires a severe economic downturn.
“What seems to be forgotten here is that inflation is a sticky, slow moving variable,” analysts wrote. “Spikes can reverse quickly, but underlying inflation tends to move in a gradual legged fashion with respect to the economy. It is going to take time to cool off the labor market and even more time to lower labor cost-driven inflation.”
Research from the New York Federal Reserve shows that inflation expectations hit an 11-year high on Monday, which analysts say will take time to moderate.
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Meanwhile, a sharp rise in inflation expectations last May prompted Fed officials to approve a 75 basis point rate hike, the first since 1994.
“The market is not a good gauge of inflation expectations for ‘real people’ and investors have an oversimplified view of the link between growth and inflation,” wrote Ethan Harris. “In our view, it is going to be extremely hard for the Fed to get inflation back to target in a two-year time span.”
The note from the Bank of America analyst came just days before the release of the new CPI data, which they say will be complicated. Economists interviewed Refinitiv, which expects inflation to rise 8.8% year-on-year in June, the highest point in 41 years.
At the same time, fears are growing on Wall Street that the Fed may cause a decline as it raises interest rates to the highest rate in three decades to catch up with runaway inflation.
Last month, Fed policymakers approved a 75 basis point rate hike, extending the federal funds target from 1.5% to 1.75%.
President Jerome Powell told reporters that a similar hike is expected in July as inflation remains stubbornly high. However, the announcement prompted investors to reevaluate the economic outlook. Officials also revealed an aggressive path of rate hikes for the remainder of 2022.
New economic forecasts released after the meeting indicate that policymakers expect interest rates to hit 3.4% by the end of the year, a level last seen in 2008.
Ethan Harris had previously estimated the probability of a recession in 2023 at around 40%.
“Our worst fears around the Fed have been confirmed: they fell way behind the curve and are now playing a dangerous game of catch up,” Harris wrote in June. “We look for GDP growth to slow to almost zero, inflation to settle at around 3%, and the Fed to hike rates above 4%.”
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