The United States is currently experiencing the worst inflation in history. As a result, the Federal Reserve was forced to take extreme measures to tame the prices that politicians deliberately dragged the economy into a deep recession.
On Friday, Bank of America strategists said market prices indicate inflation will fall to or below the Fed’s 2% target over the next two years. However, this will require 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.
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 believe will be complicated. Economists interviewed Refinitiv, which predicts inflation will rise 8.8% year-on-year in June, the highest point in 41 years.
At the same time, fear is growing on Wall Street that the Fed may cause a dip as it raises interest rates to the fastest rate in more than three decades to catch up with runaway inflation.
Last month, Fed policymakers approved a 75 basis point rate hike, extending the federal funds target range from 1.5% to 1.75%.
Chairman Jerome Powell told reporters that a similar hike is scheduled for July as inflation remains stubbornly high. However, the announcement prompted investors to re-evaluate the economic outlook. Officials also revealed an aggressive path of rate hikes for the remainder of 2022.
New economic projections released after the meeting indicate that politicians expect interest rates to hit 3.4% by the end of the year, a level last seen in 2008.
Ethan Harris 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%.”