Ethan Harris, Bank of America head of Global Economics, joins Yahoo Finance Live to discuss the economic outlook for the consumer and how the Fed could impact markets in 2022.

Video Transcript

BRIAN SOZZI: All right, the market is still trying to get a handle on how many interest-rate hikes we may get from the Federal Reserve this year. Our next guest, though, thinks we will get seven rate hikes this year. Joining us now is Bank of America head of global economics Ethan Harris. Ethan, good to speak with you here.

Wow. This note from you and your team certainly getting a lot of attention out there on the Street. What is the biggest factor behind you and your team moving to seven rate hikes for this year?

ETHAN HARRIS: Well, I think it's important to understand that the Fed is a bit behind the curve here. Normally at this stage of the cycle, the Fed would have already hiked 100 or 150 basis points, and they would still be hiking as I speak. And what's happened, I think, at the Fed is last fall they decided, OK, we're going to wait until we're absolutely certain that this is a serious inflation acceleration, absolutely certain that the labor market's going to remain strong. Now they've shifted gears.

And so what we're calling for is not at all radical. We're saying they're going to hike 25 basis points at the next seven meetings and, by the end of the year, get close to 2% in the funds rate. It sounds very radical because investors have gotten used to a Fed that's always very friendly, but when you have inflation, the Fed's got to shift gears, and they're beginning to do that.

JULIE HYMAN: Ethan, it's Julie here. I guess what I'm not quite understanding in this call is you're also cutting your GDP growth forecast to 3.6%. And so you have the Fed consistently raising rates as the economy-- it's not slowing but the rate of growth is slowing, and won't that also slowing growth sort of take care of some of the inflation on its own? So put all this together for me.

ETHAN HARRIS: Yeah, so, you know, slower growth on its own doesn't contain inflation because the growth we're talking about, 3.6% this year, will mean continued tightening of conditions in the economy. This imbalance we have right now with limited supply and strong demand is partly a supply story but it's also a demand story. Demand is extremely strong.

And we're likely to see a continued drop in the unemployment rate and other measures of spare capacity. We think the unemployment rate will hit 3% by the end of the year. So even with the slower growth, the Fed has to think about where we are a year from now, and a year from now, we're going to be in an environment where inflation is still a problem, that it hasn't completely gone away. And it's simply not appropriate to have near-zero interest rates when you have inflation of 2 and 1/2% or 3% or whatever we're going to end up a year or two from now.

BRIAN SOZZI: Ethan, what do you think-- if we do, in fact, get these seven rate hikes this year, what do you think that does to consumer spending and household wealth?

ETHAN HARRIS: Well, it's a dent in the economy, right? And again, you can't fight inflation without any pain at all. I mean, it doesn't make any sense. I mean, if you don't impose any restraint on the economy, why would inflation come down at all?

So the Fed has to impose some constraint on the economy, but it's against a backdrop of an economy with tremendous momentum. The household sector has easily record net worth as a share of income if you add up their homes and their stock portfolio. There are massive liquid savings in banks. Households have $4 trillion in above-normal bank deposits and money-market funds right now. All that money they couldn't spent in the last-- spend in the last two years is just piling up in their bank accounts, and so the fundamental backdrop for the consumer is extremely strong.

And while I do think that the stock market's going to be constrained by this Fed policy-- we've already seen a correction in the equity market-- the outlook for the consumer is still pretty good. We don't really think the Fed starts to have an impact on the economy until the end of this year and into next year after cumulative hikes start to put some real restraint on activity.

JULIE HYMAN: Ethan, this all raises a question that I've had pretty consistently during this inflation cycle, which is how much of what is going on is because of low rates and how much of it is because of constrained supply in various ways? So, you know, there has been this outlook that the supply side of it is going to work itself out eventually. How eventually is up for debate. But, you know, what happens when that supply situation is taken care of and the Fed is raising rates?

ETHAN HARRIS: Yeah, I grew up in a big family, and my mom used to say it takes two to tango. You know, it's both sides of the equation are at fault here. And, you know, I had a lot of fights with my brothers, to be honest.

Anyways, so the story right now, it's a mixture of things. Certainly the COVID shock has constrained supply. I mean, it really has pulled-- caused a big pullback in the labor market, and that's creating some of this inflation pressure.

But we can't completely ignore the demand side. You have the most aggressive fiscal policy in history that has left households flush with wealth and liquidity. Now, of course, the fiscal policy is starting to go away, but the liquidity in wealth is still there. And you have a central bank with a zero funds rate.

So the Fed's job can't control the supply side of the economy, but they can put a little bit of constraint into demand, and that's what they need to start doing. So I don't view hiking interest rates, you know, 175 basis points, 1 and 3/4% over the course of this year as being a body blow to the economy. I view it as a leaning against the inflation pressure.

And inflation's going to come down partly on its own as imbalances in the economy ease, but the Fed has a role in that too. They can't step back and say it's not our fault. We have nothing to do with this. They have to do their share, which is put a little bit of restraint on the economy and recognize that some of this inflation is permanent, not just a temporary supply shock.

BRIAN SOZZI: Ethan, think real quickly before we let you go. If we're sitting here at this point next year and we get those seven rate hikes, do you think the stock market will have been positive for this year?

ETHAN HARRIS: I think it's kind of a flattish market, to be honest. I'll fudge a little on that. I'm not sure. I mean, I think that, for now, we've had the near-term correction as the market's had to deal with the fact that the Fed isn't going to be completely friendly going forward. I mean, last fall the Fed said don't worry about inflation and don't worry about us, and they really helped drive the stock market. Now they're taking back that promise.

But I think the market will do OK. I don't think it'll be a great year. Be more of a flattish year.

BRIAN SOZZI: Duly noted. All right, we'll leave it there. Ethan Harris, Bank of America head of global economics, we'll talk to you soon.