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The Fed’s Unrealistic Approach to Inflation

In: Finance, Forex

According to the outlook released by the Federal Reserve. The U.S. will have dramatically lower inflation alongside strong economic growth that will continue to pull down the unemployment rate.

Fed officials mapped out their expectations in fresh forecasts that accompanied Wednesday’s announcement of a quarter-point rate hike.

Next year, the Fed will raise its key interest rate past the estimated neutral level, where it assures stable prices and full employment over the long run without causing a recession. A slowdown in price gains from 6.1% January’s to 4.3% by year-end and 2.7% next year. Economic growth of 2.8% this year and 2.2% next, both stronger than the long-run trend. Unemployment at 3.5% in December and at end-2023, down from 3.8%.

The Fed sees everything turning out just right, and based on current market conditions that would be considered a rare event.

Chair Jerome Powell’s presentation in his press briefing won a vote of confidence in the stock market, which closed up more than 2% for its biggest two-day gain since April 2020. Bond traders were more skeptical.

Fed Chair Jerome Powell stated that “the probability of a recession within the next year is not particularly elevated.” During a 1 hour conference Powell made clear that he and his colleagues are determined to prevent high inflation from becoming entrenched, effectively pledging to do what it takes to ensure price stability, which he stated more than a dozen times.

The Fed’s record for more than a generation now of always halting hikes at a lower level than the last peak, has people in the bond market, including fund manager Jeffrey Gundlach, questioning this assessment.

What hides behind that pattern is a steady increase in debt. The argument comes down to borrowers simply not being able to withstand much higher rates.

In a recent note, Bank of America economists align with Powell in underlining that this economic recovery is much more powerful than the last one. Bank of America economists suggest this time could be different.

In January, there were 1.7 job openings for every unemployed person. Such conditions made Powell evaluate the Jobs Market as “tight to an unhealthy level.”

Rates adjusted for inflation. Right now, are deeply negative, because the benchmark of 0.25% to 0.5% is much less than the pace of price increases. This is the second determining factor. Fed officials planned on a 2.8% peak rate for their benchmark next year and through 2024. Potentially making it both a more believable target and a less painful one. Adjusted for estimated inflation, that would be lower than the previous peak of 2018.

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