Unemployment Seen Climbing Much Higher Than Fed Expects as It Fights Inflation: Deutsche Bank

Federal Reserve Board Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, on May 4, 2022. Alex Brandon/AP Photo

Analysts at Deutsche Bank said in a recent note that the Federal Reserve’s fight to crush inflation could send the unemployment rate as high as 6 percent by the end of 2023, equivalent to around 4 million Americans losing their jobs.

After initially downplaying rising inflation as a “transitory,” an embarrassed Fed has moved aggressively to tighten monetary settings and stamp out surging price pressures.

“Given that the [federal] funds rate was essentially at zero just seven months ago, this has been quite a pivot in monetary policy,” said Charles L. Evans, president of the Federal Reserve Bank of Chicago, in a speech at the end of September.

“We also are reducing the size of our balance sheet at a relatively rapid clip,” he added, referring to a reversal of the quantitative-easing program that saw the Fed’s balance sheet significantly expand.

With all the tightening under way, Fed policymakers expect that the economy will slow and unemployment will push higher from the current 3.5 percent to 4.4 percent in 2023 and 2024.

But a recent analytical note from Deutsche Bank says the Fed is low-balling its estimate on how many Americans will have to lose their jobs as the central bank corrects its course.

“Our updated analysis continues to point to the need for a sharper rise in unemployment than embedded in the Fed’s latest projections for September,” Deutsche Bank analysts wrote.

Fed Wants ‘Softer’ Labor Market

Fed officials have spoken of the need for a tightening labor market in order to ease inflation pressures, and they have acknowledged that pushing rates higher could mean higher rates of joblessness.

Federal Reserve Chair Jerome Powell said during a press conference in September (pdf) that rate hikes could “give rise to increases in unemployment” and that “we need to have softer labor market conditions.”

While Powell added that Fed policymakers “certainly haven’t given up the idea that we can have a relatively modest increase in unemployment,” he said they’re determined to crush inflation and bring it back down to around the Fed’s target of 2 percent.

“We need to complete this task,” he said, adding that it won’t be “painless.”

Markets are now pricing in another big 75 basis-point rate hike in November and a terminal rate of 4.89 percent.

Some Wall Street analysts believe markets are undershooting how high the Fed will hike before it hits pause.

How High Will They Go?

Analysts at BNP Paribas, who expect that the U.S. economy will go into a recession in the second quarter of 2023, think the Fed will push interest rates beyond market expectations, to a peak of 5.25 percent.

“We expect a more aggressive Fed response to stickier, more pervasive inflation to push the economy into recession,” BNP said.

Economist Mohamed El-Erian, the former CEO of investment management firm Pimco, wrote in a recent opinion piece in Bloomberg that because the Fed “badly misdiagnosed” inflation last year, it has “significantly intensified” its response by hiking rates at the fastest pace since the 1980s.

El-Erian sees the Fed as walking on a tightrope, with doing too much or too little both carrying risks.

“Having to play catch-up, the world’s most powerful central bank risks pushing the U.S. economy into recession, throwing millions of people out of work, worsening income inequality, undermining its independence, and causing economic fires around the globe,” he wrote.

“Yet, also as worrisome is the possibility that an early ‘pivot’ in Fed policy would risk leaving the United States languishing in a stagflationary swamp,” he added, referring to stagflation, which is a combination of sluggish growth and high inflation.

Stagflationary winds in the United States have intensified, with recent data from the Federal Reserve Bank of Richmond showing a sharp drop in manufacturing activity at the same time as inflationary pressures grew.

Economist Peter Navarro, who served as an advisor under the Trump administration, believes the United States is already suffering from stagflation due to the “fickleness” of President Joe Biden, Congress, and the Federal Reserve.

“This is just the beginning. This economic crisis is just beginning, and it’s going to be as bad or worse and as long as it was during the 1970s,” Navarro told Epoch TV.

The key to pulling the nation out of its stagflationary slide, he said, is to restore the policies championed by former President Donald Trump.