Markets may be in for an 'enormous shock' as the Fed could have to kick up interest rates to a 40-year high to fight inflation, strategist says

A woman shopping in a grocery store
Moyo Studio/Getty Images
  • The markets may be in for a major shock as the Fed drives rates up to unforeseen highs to fight inflation.

  • That's according to Dominique Dwor-Frecaut, who told Bloomberg disinflation is "sadly fiction."

  • Inflationary pressures are starting to stabilize and that could lead to even higher borrowing rates.

Disinflation is a "fiction," and US monetary policymakers may need to nearly double borrowing rates from current levels to tamp down hot inflation, a move that would rock markets, according to a strategist at financial research firm Macro Hive.

The Federal Reserve may find itself driving up the key Fed funds rate to 8%, says Dominique Dwor-Frecaut, senior macro strategist at Macro Hive. An 8% rate is much higher than the current range of 4.5%-4.75%, and it hasn't been that high since 1985.

"If I'm correct on inflation and the Fed's policy rate, it's going to be an enormous shock for the market," Dwor-Frecaut said in a Bloomberg interview published late last week. She had expected to see a deeper inversion in the yield curve and the 2-year yield moving higher. The 2-year yield on Wednesday reached a 2023 high above 4.63% after January retail sales rose at a faster-than-expected rate of 3%.

Stocks in 2022 sank into a bear market as the Fed rapidly jacked up the benchmark rate from 0% to hit back at a surge in consumer price inflation. The CPI reached a peak of 9.1% and this week data showed the headline rate easing to 6.2% in January, but there was rise in monthly prices for rent, energy and food.

"[Just] look at the breakdown of data. Core goods prices that were falling, are actually stabilizing," she told Bloomberg TV in an interview on Tuesday. "Look at shelter-price inflation. Where is that disinflation that we've been promised on housing? Look at property prices, they are stabilizing," she said.

Also, "the reason we've seen a slowdown in wage growth is because the labor market is normalizing … all these are great news for the economy, but the bad news for disinflation," she said. The idea that the economy is heading into a disinflationary period, is "sadly, fiction," she said.

The 8% rate call "isn't something I plucked out of thin air," Dwor-Frecaut said in the televised interview,  explaining her view stems from her analysis working with the Taylor Rule, a formula that provides recommendations for where the Fed should set short-term interest rates.

The Fed could raise rates up to 7% as well, but the Fed funds rate would still be much higher than where it is now, she said. Policymakers starting in March could look at adding one or two more rate hikes to the terminal Fed funds rate, she said. Inflation resurging as China reopens its economy may force the Fed to keep pushing rates higher into year-end.

Federal Reserve Chairman Jerome Powell recently said it was "gratifying to see the disinflationary process now getting under way," while policymakers are still battling inflation.

Read the original article on Business Insider