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Guggenheim: Fed Badly Behind Curve, Tightening Into Downturn

US OUTLOOK/OPINION

Guggenheim Investments says the US could enter recession as early as 2H 2023, amid a "collision" between Fed tightening and a strong but cooling US economy.

  • They note a significant divergence in the past year between Fed policy and dual mandate variables: "Historically, the Fed would change the fed funds rate in response to changes in the unemployment rate and changes in inflation ... Simply adding up these changes has tracked well with changes in Fed policy." [See chart.]
  • The divergence is largely due to the pandemic shock, but also the Fed's updated policy strategy and a "misreading of the inflation surge as transitory". Whatever the reason, Guggenheim sees the Fed as "badly behind the curve".
  • If the usual historical relationships had held, the Fed funds rate would already be around 2.5% and set to come down with inflation decelerating and the pace of the unemployment rate declining.
  • But now, the Fed is set to hike to 3.5% into 2023, and "well before it reaches this terminal rate the Fed will increase the risk of overshooting ... and starting a recession" as early as 2H 2023.

Source: Guggenheim

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Guggenheim Investments says the US could enter recession as early as 2H 2023, amid a "collision" between Fed tightening and a strong but cooling US economy.

  • They note a significant divergence in the past year between Fed policy and dual mandate variables: "Historically, the Fed would change the fed funds rate in response to changes in the unemployment rate and changes in inflation ... Simply adding up these changes has tracked well with changes in Fed policy." [See chart.]
  • The divergence is largely due to the pandemic shock, but also the Fed's updated policy strategy and a "misreading of the inflation surge as transitory". Whatever the reason, Guggenheim sees the Fed as "badly behind the curve".
  • If the usual historical relationships had held, the Fed funds rate would already be around 2.5% and set to come down with inflation decelerating and the pace of the unemployment rate declining.
  • But now, the Fed is set to hike to 3.5% into 2023, and "well before it reaches this terminal rate the Fed will increase the risk of overshooting ... and starting a recession" as early as 2H 2023.

Source: Guggenheim