Sep 23, 2022
U.S. Fed trying to catch 'a falling knife' with inflation: TD chief economist
U.S. in a growth recession, Fed can't avoid a wage price spiral: Former Fed governor Larry Meyer
The U.S. Federal Reserve’s aggressive rate hike strategy in reaction to near-term data is like “catching a falling knife,” said Beata Caranci, chief economist and senior vice president of TD Bank Group.
“When you envision how you would catch a knife with your hands, you would put them together in a prayer and hope to get it on its side,” Caranci said in a phone interview Friday.
“It’s effective imagery as it's not easy to do, it takes quite a bit of skill and it has quite a bit of risk. It encapsulates everything I'm thinking right now, in regards to what we’re going through with the U.S. Fed.”
'BOXED ITSELF INTO A CORNER'
In the past, the U.S. central bank trained markets to look forward and focus on how rate hikes will impact the economy in the future, said Caranci.
But, she said the U.S. Federal Reserve has now made markets more concentrated on near-term data, and in turn, has “boxed itself into a corner.”
She added this may result in a “hard pivot on communication” and the U.S. Federal Reserve might have to keep hiking in order to anchor expectations, even when there’s compelling evidence that inflation is coming down.
“That's why I don't really buy into their forecast of what they're saying on the economy or the dot plot because if they go up to that level, I don't think the economy will perform as strongly as they're communicating,” Caranci said.
The "dot plot" shows projections for the federal funds rate, with a median forecast by central bank officials expecting interest rates to be at 4.4 per cent by the end of 2022. (so this number is what the central bank is projecting?)
“On the flip side, we think the economy will capitulate and they'll have to cut which they're not indicating either in 2023, but part of that is a strategy.”
U.S. FED SIGNALS MORE PAIN AHEAD
Earlier this week, the U.S. Federal Reserve hiked the target for its main policy rates three-quarters of a point for a third consecutive time.
In a press conference, U.S. Federal Reserve Chair Jerome Powell signalled the central bank would continue to raise rates and again acknowledged it could cause pain for some Americans.
“We've just moved I think probably into the very lowest level of what might be restrictive and, certainly in my view and the view of the committee, there's a ways to go,” Powell said.
RISK OF A U.S. FED-TRIGGERED RECESSION
In an interview Wednesday morning, Earl Davis, BMO Global Asset Management’s head of fixed income, said there’s a 99.9 per cent chance the U.S. Federal Reserve will trigger a recession if it continues with its aggressive rate-hike strategy.
Davis said that “it may end up being a policy mistake. But the playbook says you have to get a recession” in order to get inflation back to manageable levels.
“I have no idea where that person came up with those odds because if it was that obvious, I think the U.S. Fed might pick their relief up,” Caranci said.
“But, I think if the U.S. Fed follows through with what they've communicated in that dot plot, I think that the U.S. would likely be moving towards a recession.”
Caranci said it’s important for economists to define what they think a future recession could look like, as “it could be like 2001, which was relatively shallow and then we have the other side of it with 2008.”
“I think if we do get into a recession it could be 2001, but most likely slightly deeper than what we saw then,” Caranci said.
“I don’t think it would be close to the scale of 2008. I think the differences on why we would say that is because we just don't see the financial risks embedded in the U.S. housing market, which was quite pervasive in taking down consumer sentiment and crippling the financial sector.”
FUTURE OF THE U.S. FED
Caranci bets that the U.S. Federal Reserve will hike at the next two interest rate meetings, as she doesn’t think inflation or the labour market will change drastically enough to sway central bank officials before the end of the year.
But she said there’s a big lesson to be learned from this experience.
“They should have remained forward looking, which we all know now,” Caranci said.
“I think they will go back to the prior way (of viewing rates hikes) and won’t be looking to test the limits anymore, appreciating if you need to have a little bit of sacrifice on the employment side for the stability of inflation, it’s a better situation than what we're in today.”