BofA warns 75 basis points of Fed hikes may not tame inflation

Bank of America is maintaining its forecast for two additional Federal Reserve rate hikes this year while questioning whether that total tightening of 75 basis points will be sufficient to return inflation to the central bank's 2% target. In a client note obtained by TheStreet, the bank stated that it continues to call for quarter-point increases in October and December.

The Fed's benchmark Federal Funds Rate currently sits in a range of 3.75% to 4% following a unanimous 12-0 decision on Sept. 16 to raise rates by 25 basis points. This marked the first increase since January 2023 and was widely expected by traders. The decision followed persistent price pressures, which the source attributes to rising energy costs from the Iran War and related geopolitical shocks.

BofA noted that the Sept. 16 statement dropped language linking inflation to supply shocks, effectively removing excuses for price persistence. The accompanying Summary of Economic Projections indicated that the median forecast for the year-end funds rate aligns with one more 25-basis-point increase from the current midpoint. Additionally, sixteen of the 18 participating policymakers expect at least one further rate increase before the year ends.

The bank disagrees with analysts who argue the Fed is making a policy mistake by raising rates. The note argued that from a monetarist perspective, robust nominal growth requires slowing the velocity of money through higher rates. BofA asserted that underlying inflation has remained around 2.5% for several quarters because policy has not been tight enough to push it back to the 2% goal.

Fed Chairman Kevin Warsh, who served as a Fed governor from 2006 to 2011, reaffirmed a commitment to taming inflation during a speech at Jackson Hole last month. At the FOMC press conference, Warsh stated that while the Fed cannot affect individual prices like oil or foodstuffs, it will ensure changes in relative prices do not broaden out into second and third-order effects. The BofA note observed that Warsh reinforced on Sept. 17 that the job is not done.

The CME Group FedWatch Tool currently prices in a 55.4% likelihood of another quarter-point hike on Oct. 28 and an 89.6% probability of at least one additional hike on Dec. 9. Despite this, BofA warned that the planned 75 basis points of tightening might not be enough if supply-driven inflation remains stubbornly high.

The bank identified a scenario where additional inflation from the Iran conflict enters the pipeline beyond its base case estimates. This would leave the Fed with a difficult choice between accepting years of above-target inflation or applying more pressure on aggregate demand than previously needed to hit the target, risking a recession. The note concluded that either choice would tarnish Warsh's legacy, leaving the final outcome to be seen.