Expectations Of A Recession And Rate Hikes Are Rising On Wall Street

According to some Wall Street research firms and several economists, recent evidence suggest the Federal Reserve may need to raise interest rates more than anticipated in order to control inflation, which would increase the likelihood of a recession.

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The projected range for rates has increased by nearly a quarter of a point over the past few days as a result of the markets' accelerated rate expectations, which are now in the range of 5.25%-5.5%.

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Yet even that might not be sufficient.

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Wolfe Research stated in a client note on Monday that "we now feel it is likely that the Fed will have to rise to 6% to set inflation on a sustainable path downward, and that a relatively serious recession is going to hit in the months ahead."

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The forecast comes before the central bank meeting in March, when market participants anticipate a further quarter-percentage point, or 25 basis point, rate increase. After the inflation rate reached its greatest level in 41 years in March 2022, it began to increase.

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Wolfe observed that various economic data points from late 2022 amounted to "head fakes" suggesting inflation is lower than it actually is. Some Fed officials, including Governor Christopher Waller, have cited the phrase as justification for the institution's aggressive tightening of monetary policy.

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The company anticipates that continued inflation and increasing rates will significantly weigh on the markets. Wolfe's pessimistic outlook for the intermediate term is strengthened by this.

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There are more doubts elsewhere.

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Yet Fed officials have mostly maintained the thesis that they can make the economy land softly, skepticism is starting to spread.

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For instance, Bank of America stated that it believes policymakers may need to raise the benchmark funds rate to the 6% to 7% level. A recession is likewise predicted to be the most likely consequence by the bank's economists.

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According to the bank's senior economist Aditya Bhave, "we believe that consumer demand will likely had to decline somewhat for inflation to return to 2%." "This will probably create a recession because the economy's non-consumer sectors already appear fragile. The strength in the January activity and inflation figures suggests that the Fed might have to go significantly farther to discover the point of pain for the consumer. There are increasing right-tail threats to the terminal rate.

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Moreover, recent data suggests that inflation has returned after slowing down in the latter part of last year.

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The production price index rose 0.7% for the month and 6% annually, while the consumer price index grew 0.5% in January and is up 6.4% from a year ago. Possibly more significantly, the Fed's favored indicator, the personal consumption expenditures price index, rose by 5.4% annually and 0.6% monthly. Each of those values exceeded the central bank's 2% target and was higher than anticipated.

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Moving to 6%

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The Fed's rate hikes have not yet broadly reduced consumer demand, which is a necessary step in bringing inflation down, according to Bhave.

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The main conclusion from our study is that for inflation to get back to the Fed's objective, aggregate demand needs to decline significantly, he said. "But only to a certain extent, further supply-chain normalization and a slowdown in the labor market will be helpful. In addition, these processes are taking longer than expected by the marketplace and us.

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The lesson is that "the Fed could have to hike rates closer to 6% to get inflation back to target," Bhave continued. "The durability of demand-driven inflation means that."

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Deutsche Bank chimed in as well, stating that in order to convey a clearer message about its commitment to inflation at the March meeting, the Fed may have to consider raising rates by a half-point.

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Two recent white papers—one from the Cleveland Fed and the other from a group of economists that included former Fed Governor Frederic Mishkin—align with the theories about the direction the Fed should go.

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The later study stated that there is no precedent for the Fed being able to achieve disinflation without sparking a recession. It was presented on Friday at a University of Chicago monetary policy symposium in New York.

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The authors of the Cleveland Fed white paper advised the institution to reevaluate its 2% inflation target because it is unlikely to be attained any time soon. It added that "a significant recession would be necessary" for the Fed to reach its objective and that core PCE inflation is projected to fall off only to 2.75% by 2025.