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Deutsche Bank Sees 5%-6% Fed Target Rate and Deep U.S. Recession

·2 min read
Deutsche Bank Sees 5%-6% Fed Target Rate and Deep U.S. Recession

(Bloomberg) -- The Federal Reserve is likely to need to engage in the most aggressive monetary tightening since the 1980s to tamp down an inflation rate at a four-decade high, which will lead to a deep U.S. recession next year, Deutsche Bank AG economists warned.

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“We assume conservatively that a Fed funds rate moving well into the 5% to 6% range will be sufficient to do the job this time,” the authors including David Folkerts-Landau, group chief economist and head of research, wrote in a report Tuesday. “This is partly because the monetary-tightening process will be bolstered by Fed balance-sheet reduction, which our U.S. economics team estimates will be equivalent to a couple additional 25 basis-point rate hikes.”

This monetary tightening and the financial upheaval that accompanies it “will push the economy into a significant recession by late next year,” Folkerts-Landau said, adding Deutsche sees the unemployment ultimately rising “several percentage points.”

The Deutsche economists -- by their own admission -- are much more pessimistic than most other major forecasters. Goldman Sachs Group Inc. estimated chances of a contraction at about 35% over the next two years. Bloomberg Economics’ recession-probability model has estimated a 44% chance of recession happening before January 2024.

Fed Chair Jerome Powell and his colleagues have said their goal is to achieve a soft landing -- cooling the U.S. economy to bring inflation back down toward their 2% goal while preserving a robust labor market. The Federal Open Market Committee is expected to raise rates by half a percentage point at its May 3-4 meeting and announce it’ll start shrinking its $9 trillion balance sheet.

In the Deutsche economists’ view, the FOMC’s plans to raise rates to a neutral level -- one that neither stimulates nor contracts growth -- of around 2.5% won’t go nearly far enough to ease inflation. That’s because of a rising-price psychology taking root among American households, and an extremely tight labor market, where unemployment has fallen to 3.6%.

Deutsche estimated a neutral rate that’s much higher than the Fed’s view, around 5%, and projected the 10-year U.S. Treasury yield will rise to 4.5% to 5%.

“We will get a major recession, but our strongly held view is that the sooner and the more aggressively the Fed acts, the less longer-term damage to the economy there will be,” the authors concluded.

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