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Economist: ‘There’s certainly the justification’ for the Fed to go for a 75 basis point hike

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NatWest Global Economics Head of US Michelle Girard joins Yahoo Finance Live to discuss inflation, rate hikes, consumer sentiment, recessionary risks, and the expectations for Tuesday’s FOMC meeting.

Video Transcript

- So, Michelle, as you're seeing this happen, obviously, added pressure on the Fed here, but a lot of people still expecting the Fed to stay the course. Is that the right move by taking that 75 basis points off the table?

MICHELLE GIRARD: Well, it certainly in hindsight doesn't look like it was the right move to have done in the May meeting. Much better perhaps to have left yourself the flexibility to respond. I mean, obviously, the Fed can do what they need to do depending on evolving conditions. But in some ways, having signaled the base case of 50 in June and another 50 in July, now to go 75 risks looking panicked.

Now, the market is pricing in currently about a 30% chance that the Fed will take that larger 75 basis point move this week. So there was an article in the press this afternoon that some people feel may have possibly been a little bit of a leak of a signal to sort of prep the markets that in fact perhaps the Fed could go 75. Again, whether they take that step now or just signal that we're going to continue to see more action even after June is somewhat of a question. But that's what certainly led to the sell off today, the market pricing in more Fed, not just this week, but in the months to come.

- Barclays and Jefferies both projecting 75 point hike on Wednesdays. Is it the Fed's job to adapt to circumstances? Them being behind the curve is how we got into this situation. How much have conditions changed since Jerome Powell last spoke about that 50-point hike?

MICHELLE GIRARD: Well, again, I feel like at the time, we were sort of like, why would the Fed make such a statement and sort of lock themselves into just 50, again, not allowing themselves the flexibility to adjust the data, even though the Fed themselves repeatedly indicate, look, we'll do what is required given the data that we're seeing. So they absolutely should be responsive.

The fact that they were very clear that they felt that inflation had likely peak-- even many of us had thought that March was likely to be the peak in inflation. And yet the numbers have continued to move higher. I do think that there's enough there certainly for the Fed to be able to say, look, we've seen new data. We need to respond to that data. There's certainly the justification for going 75. Again, it's simply for the Fed and policymakers the lesser of two evils. Should you deliver? Do you risk looking panicked? Do you risk looking too reactive? That's what they will weigh when they meet this week.

- Michelle, when you take a look at what's at play here, the rising inflation, which we've been talking about, consumer sentiment at a record low, S&P today falling into bear market territory, the Fed hasn't yet obviously been able to rein in inflation, how are you looking at the odds of a recession? Do you think it's likely over the coming months?

MICHELLE GIRARD: Well, I think a recession is perhaps likely. I'm not sure I think over the coming months. Certainly when you see the kind of action and financial conditions tightening that we've seen over the last week, the odds have gone up for a slowdown sooner. But I kind of think that underlying the consumer is still a decent amount of cushion, if you will.

But I have been worried all along that in order to really get inflation down-- and not just down from 8% to 4%, which is kind of our forecast for where the inflation rate will head this year-- but to get it all the way back down to 2%, it might take that sharp slowdown, a recession even, if you will, a mild recession, in order to curtail demand enough to get inflation back to target. So that has been my concern that ultimately-- not maybe so much in '22-- but ultimately the Fed will have to take rates more restrictive than they anticipate to get inflation back to the target level.

- And, Michelle, I want to ask you about how people are actually feeling because a lot of people feel as if they're in a recession because, obviously, the money isn't going as far because of inflation. But the economic fundamentals do seem to be strong. What grade would you give the US economy based on the fundamentals right now?

MICHELLE GIRARD: Well, again, I think that the actual numbers themselves, if you look at various measures of household balance sheets, of the ability for households to continue to service debt, I mean, debt service levels are very low. Consumers are continuing to spend. Despite higher prices, they have continued to spend. I mean, all of the current activity numbers at the moment don't look quite so bad.

Of course, what we care about is, where are we headed? And you can see from those-- disastrous is a strong word-- but record low levels of consumer sentiment reported last Friday, where consumers are feeling quite concerned about the outlook for the economy, about their own personal financial situation as a result of these higher the higher inflation numbers. I mean, all of that is quite worrisome. And that's what we will be watching. You're seeing consumers becoming a bit more reliant on credit card debt. They're spending more on credit cards. Again, the numbers in terms of delinquencies right now, very low.

But if you extrapolate some of the trends, that's the concern. So as I said, I'm not so much worried about the economy over the next three or four months. I'm more worried as we get into 2023 and the second half and the Fed has to perhaps keep going that, ultimately, it's going to be tough. It's going to be I think just a rough time for the economy and, quite honestly, for the markets as the Fed tries to remove accommodation, back away from the market support that's been given, and actually bring inflation down.

- And we saw that reflected in the markets today. Michelle Girard, always great to have you. NatWest Global Economics head of US. Thanks so much for joining us.