Bank of America Expects the Fed to Keep Hiking Rates Until ‘Point of Pain’ for Consumer Demand

Bank of America has warned that the Federal Reserve will have to keep raising interest rates until it finds “the point of pain for consumer demand.” The Bank of America senior economist Aditya Bhave published a note earlier this week warning that the Federal Reserve could increase interest rates beyond the market’s expectations to bring inflation down to its 2% target. This warning comes as an additional 25-basis-point interest rate hike in June is expected.

According to a memo seen by Fortune, the bank thinks that “additional Fed hikes would also mean more pain for the interest-sensitive non-consumer sectors, such as housing.” The economist cautioned that the “resilience of demand-driven inflation means the Fed might have to raise rates closer to 6% to get inflation back to target.”

Several other economists have also cautioned that the Fed cannot reach its 2% inflation target without “crushing the economy”. Allianz chief economist, Mohamed El-Erian, believes that “2% is not the right target”, as it is very challenging at a time when households and firms are already trying to deleverage.

U.S. Treasury Secretary Janet Yellen stated that “disinflation is not a straight line” earlier this week. While acknowledging that “there’s more work to be done”, she dismissed the idea that a recession is inevitable, adding that “core inflation still remains at a level that’s above what’s consistent with the Fed’s objective”.

However, Aditya Bhave differs in opinion and wrote that “a recession appears more likely than a soft landing”. In his view, “a slowdown in consumer demand, which our analysis suggests is necessary to bring inflation back to target, would likely lead to an outright recession.” Consumer spending makes up 68% of GDP, and additional Fed hikes would also mean more pain for interest-sensitive non-consumer sectors such as housing.

He further explained, “Our base case is that a recession will start in Q3 2023. Risks are skewed towards an extended period of consumer resilience, stickier inflation, and more Fed hikes. Either way, however, the lesson for investors is: No pain, no gain.”

Several Fed officials have already said that more rate hikes are needed to bring inflation under control. Earlier this week, Federal Reserve Bank of Atlanta President Raphael Bostic warned about “disastrous” economic consequences if the Fed loosens its policy prematurely. He said that carefully communicating its policy path to markets, with commitments to continued support, would promote a sustainable recovery.

Jeffrey Gundlach, known as the “bond king,” has also been warning of “painful outcomes” in the next recession. Economist Peter Schiff cautioned that the Fed could be fighting a “complete economic collapse”. These warnings suggest that the situation is at a critical juncture and that policymakers must tread carefully to avoid serious unintended consequences.

Furthermore, many experts believe that interest rates are one of the most potent tools at the Federal Reserve’s disposal, and it would be best if they used them cautiously to balance their objective of having an optimal inflation rate with maintaining adequate economic growth.

In conclusion, Bank of America’s warning regarding the Fed raising interest rates is a wake-up call for the policymakers in the United States. Federal Reserve officials must tread a fine line between their dual mandates of stabilizing prices and promoting maximum employment to avoid serious unintended consequences. While some believe that the Fed should use its various tools carefully, especially the interest rate hikes, others warn that failing to react aggressively could also lead to disastrous economic consequences in the future.


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