Major Banks See Federal Reserve Raising Interest Rates Beyond 5 Percent as Inflation ‘Refuses to Soften’

Federal Reserve Board Chairman Jerome Powell takes questions during a news conference following a Federal Open Market Committee meeting at the Federal Reserve Board Building in Washington, on Nov. 2, 2022. Mandel Ngan/AFP via Getty Images

Goldman Sachs, Deutsche Bank, the Bank of America (BofA), and other financial institutions are expecting the Federal Reserve to extend its interest-rate hikes as elevated inflation and strong employment maintain upward pressure on prices.

BofA now expects a pause in interest rate hikes in July rather than earlier expectations of June. “Resurgent inflation and solid employment gains means … the Fed might have to hike further if inflation, job growth, and consumer demand refuse to soften,” economists from the bank wrote in a recent note, according to Forbes. Over the next three policy meetings, BofA estimates the Fed to raise by rates 25 points each. This would take interest rates, which are currently in a range of 4.50–4.75 percent, to a range of 5.25–5.5 percent.

“In light of the stronger growth and firmer inflation news, we are adding a 25 basis-point rate hike in June to our Fed forecast, for a peak funds rate of 5.25–5.5 percent,” Goldman Sachs said in a note on Thursday, cited Reuters.

Deutsche Bank updated its Fed rate predictions and now expects the central bank to add in two 25 basis-point hikes in June and July, taking the rate to 5.6 percent from its earlier estimate of 5.1 percent.

The Federal Reserve has raised interest rates in all of its previous eight meetings. In February, rates were hiked by 25 basis points following a 50 basis-point hike in December. During the four previous meetings, the central bank had raised interest rates by 75 basis points each.

Decades-High Inflation and Employment

Speaking at the Economic Club of Washington earlier this month, Federal Reserve Chair Jerome Powell indicated that inflation and employment are two key factors that will influence the bank’s direction on interest rates.

“If we continue to get, for example, strong labor market reports or higher inflation reports, it may well be the case that we have to do more and raise rates more than is priced in,” Powell said.

“I think there’s been an expectation that it’ll go away quickly and painlessly, and I don’t think that’s at all guaranteed. That’s not the base case,” he added. “The base case is … that it will take some time. And we’ll have to do more rate increases, and then we’ll have to look around to see whether we’ve done enough.”

In January 2023, the annual inflation came in at 6.4 percent. Since January 2022, annual inflation has remained above 6 percent for every single month, which is far off from the Fed’s target inflation rate of 2 percent.

Meanwhile, the U.S. economy added 517,000 new jobs in January, which is almost double the 260,000 job additions in December. It was also far higher than economist expectations of 185,000 jobs. The unemployment rate fell from 3.5 to 3.4 percent, remaining below market expectations of 3.6 percent.

Federal Reserve and Recession

The Fed’s “tighter policy” has begun to cool down the economy, “though with a lag,” according to an analysis by research group The Conference Board published this month

It expects the economy to slip into a “broad, but shallow, contraction” as the full impact of the Fed’s rate hikes continues to weigh down on consumers and businesses. The Conference Board expects a recession to kick off this quarter and last for three quarters.

Meanwhile, BofA economists are expecting a delayed, shallower, and stretched-out recession beginning in the third quarter, extending into the first quarter of 2024. In an interview with Fox, Savita Subramanian, the head of U.S. equity and quantitative strategy at BofA, raised concerns about the Fed’s quantitative-tightening policy.

“What I worry about is that nobody is talking about quantitative tightening. The Fed bought trillions and trillions and trillions of dollars over the last 10 years. And now, they’re about to unwind that, they’re in the process of unwinding that. Why aren’t we more worried about that than the layoffs happening in technology stocks?” she said.