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Fed’s benign GDP, inflation forecast ignores recession risk

After the central bank tightened monetary policy and updated old economic forecasts since the end of last year, there has rarely been such a striking disagreement about the Federal Reserve’s strategy as it is today.

As expected, the Federal Open Market Committee raised the federal funds rate target by a quarter percentage point last week to 0.25% to 0.50%. At the same time, the policy-making committee released an overview of the economy. Inflation in 2022 and federal funds expectations are significantly higher and expected economic growth is significantly lower than predicted in the previous SEP released in December when Omicron, not Ukraine, exceeded the list of concerns. predict. Glide pass expected in the next two years.

The FOMC predicts that inflation will fall without harming gross domestic product or unemployment. Inflation rates of 2.7% in 2023 and 2.3% in 2024 are expected, rising from 2.3% and 2.1% in December, respectively, to the Federal Reserve’s 2% long-term target. This will also fall from the 2022 forecast of 4.3%, but there will be a significant improvement over the 12 months from a 5.4% rise in the consumer spending deflator (Federal Reserve Board recommended inflation gauge). January (PCE numbers are significantly lower than the more widely followed consumer price index, which was running at a 40-year high of 7.9% in the latest readings.)

This year’s unemployment forecast remains unchanged at 3.5%, and the 2024 unemployment forecast is up only 0.1 points to 3.6%.

The median forecast for real gross domestic product growth in 2022 has been revised downward from 4.0% to 2.8%. This basically incorporates this year’s events, but GDP forecasts for 2023 and 2024 remained unchanged at 2.2% and 2.0% in December. By the end of 2021, the FOMC expects the median federal funds rate to be 1.9%, even though the federal funds rate could be tightened significantly more than previously expected. This is more than double the 0.9% expected three months ago. The median is currently projected to be 1.6% and 2.1% to 2.8% at the end of 2023 and 2024, respectively. In addition, the FOMC’s forecast for the next two years is higher than the 2.4% forecast in the long run. -Federal Funds Rate Execution — Shows relatively strict policies.

Taka, who supports stricter monetary policy, and pigeons, who want less restrictions, call such Anodyne’s economic consequences unlikely. -Kumal Global Strategy.

Joseph said it’s far tougher than the Fed’s six additional quarterpoint increases (1.75% to 2% by December) to reduce annual inflation by 4 percentage points from its current pace by the end of 2022. He added that tightening would be needed. Carson, former Chief Economist of AllianceBernstein. The Treasury’s inflation-protected securities market is expected to be well above the Fed’s expectations over the next five years, reaching its highest level since January 2003, at around 3.5%, according to data from the Federal Reserve Bank of St. Louis. ..

Simona Mokta, Chief Economist at State Street Global Advisors, said the Fed’s outline of tightening measures risks causing a recession in 2023 or 2024. With SEP.

David Rosenberg, synonymous with Rosenberg Research, points out that the Fed’s tightening cycle has historically a 75% chance of causing a recession. The stock market, and incredibly flat yields. “

Not surprisingly, Fed boss Jerome Powell looks at the outlook much more calmly. He characterizes the US economy as incredibly strong and features a strong labor market with 1.7 jobs per unemployed. The FOMC will review each future economic data. If the meeting, and the numbers indicate that the panel should move faster, it will.

Powell added that the Fed’s balance sheet outflow, another factor in tightening policy, would be comparable to another federal funds rate hike. That part of the policy adjustment may be announced at the FOMC from May 3rd to 4th. meeting.

Mokta believes the Fed can adjust its policies agilely and flexibly in the event of signs of a recession. She says this is possible by the third quarter. About 30% chance of a technical recession.

Rosenberg sets the recession probability at 100% if the yield curve reverses, and yields on 2-year government bonds are higher than the benchmark 10-year bond. 0.25 Percentage Point-The place where you stood in early March 2020, the beginning of the pandemic. He argues in a client note that the only way to reduce current inflation from supply chain problems and soaring commodity prices exacerbated by Russia’s Ukrainian war is “to crush demand.” With that score, a poll by Deutsche Bank clients released Friday shows a 44% chance of a recession in 2023.

What makes it harder to fight inflation now, says Sri-Kumar Barron’s, Price pressure is shifting from goods to services, especially rent. Between traditional rent and “owner’s equivalent rent” (an exaggerated estimate of the amount a homeowner pays to rent his home), they account for about 35% of inflation. Evercore ISI’s own rent and home price surveys show that inflation is unlikely to slow as central banks expect.

To reduce inflation as predicted by the Federal Reserve, a generation ago under Paul Volcker, who raised interest rates to nearly 20% to crush record inflation in the late 1970s and early 1980s. Srikmar argues that strict policies have been enacted. Rosenberg observes that Powell calls Volker the greatest civil servant of his time. It was characterized by a series of recessions in the 1980s and 1981-82.

In fact, the Fed’s view of the decline in inflation on a scale was dramatically tightened in monetary policy, as seen in 1980 and 1981, 1974-75, and between 2008 and 2009. It was added by Mr. Carson after the financial crisis in Japan. A cumulative Fed rate hike of 1.75 percentage points does not bring about the sharp easing of inflation predicted by monetary authorities given the tight labor market.

As the Fed shrinks its balance sheet, bond vigilantism may rebound, rising to 3% and approaching 4%, Carson wrote in an email. The asset markets have hit the real economy, as it happened after the collapse of the dot-com bubble in 2000 and the housing bubble in 2006-07. A series of Fed rate hikes and balance sheet cuts pushed stocks to the edge of the bear market, but the Fed’s inflationary struggle did not “achieve the mission.”

If there is one thing these economists agree on, the Fed could reduce inflation from its current 40-year highs and design a soft landing without raising unemployment or starting a recession. Is low. The four most dangerous words for investors are “this time is different”. Probably not.

Correction and amplification

Simona Mocuta is the Chief Economist at State Street Global Advisors. Earlier versions of this column misspelled her name.

Write to Randall W. Forsyth (randall.forsyth@barrons.com)

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