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The Federal Reserve waited too long to start fighting inflation and now runs the risk of dragging the economy into a recession, according to Bank of America’s top economist. On the heels of the central bank’s 75 basis point rate hike Wednesday, BofA global economist Ethan Harris said the Fed is being forced into such aggressive moves by inflation now running at its hottest pace since late 1981 . “Our worst fears around the Fed have been confirmed: they fell way behind the curve and are now playing a dangerous game of catch up,” Harris said in a client note Friday. “We look for GDP growth to slow to almost zero, inflation to settle at around 3% and the Fed to hike rates above 4%.” Harris isn’t predicting a recession yet, but said the probability of one happening in 2023 has risen to 40%. Gross domestic product declined 1.5% in the first quarter, and the Atlanta Fed expects the second quarter to be flat. Consecutive quarters of negative growth are considered a rule of thumb for a recession, though the National Bureau of Economic Research says it uses other factors as well before making an official declaration. Along with the rate hike, Fed officials indicated the benchmark funds rate will finish the year around 3.4%, an upward revision of 1.5 percentage points from the March outlook. Policymakers still see GDP growing this year around 1.7%, but that would mark a substantial fall from 2021’s 5.7% pace. Harris said the scenario has played out in a similar fashion to a warning the bank issued more than a year ago. “In the spring of 2021 we argued that the biggest risk to the US economy was a boom-bust scenario. We worried that the Fed would take too long to put the brakes on,” he said. “We asked, if the fiscal authorities are doing so much stimulus why does the Fed need to add fuel to the fire with unusually late policy normalization? Over time the boom-bust scenario has become our baseline forecast.” In November, Harris said, he wondered “if the Fed would ever get serious about fighting inflation.” Separate releases Friday affirmed the Fed’s verbal commitment to battling escalating prices. Chairman Jerome Powell promised that the Fed is “acutely focused” on inflation , while a Fed report to Congress on monetary policy said the approach would be “unconditional.” While Harris said the Fed has put itself in a better position with the rate increases, he thinks it will have to go further than the “dot plot” of individual members’ expectations indicates. The plot points to a median expectation of a 3.8% funds rate by the end of 2023, but BofA is looking for something in excess of 4%. Five of 18 Fed officials in this week’s dot plot indicated a rate above 4%. The chart then indicates one or two rate cuts in 2024 to bring the funds rate back to 3.4%, before it settles in at a longer-run rate of 2.5%. “Where we disagree with both the Fed and the markets is the idea that the Fed will be cutting in 2024,” Harris wrote. “That is certainly possible if there is an outright recession. However, our baseline forecast assumes the Fed will be like a deer in the headlights: unsure over whether to react to very weak growth or still high inflation.”
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