The largest reason for optimism that a recession caused by the Federal Reserve can be avoided next year has just been edited away. The upward adjustments to hourly pay in September and October, followed by an even greater increase in November, pushed wage growth well beyond the range consistent with the Fed's inflation objective of 2%.
In actuality, there is a growing consensus that the only way for the U.S. economy to avoid a harsh landing and a worse decline for the S&P 500 is for the Fed to lift its inflation objective. Prior to halting its rate hikes, the Federal Reserve may be willing to do so, but would require additional cooling.
Joe Brusuelas, chief economist at RSM, told IBD that the 2% inflation target "is a lot more elastic than the Fed is letting on, because I don't think there's any constituency out there for the bloodletting that would be necessary" to achieve it.
According to Brusuelas, the Fed would need to increase unemployment to 6.7% in order to restore inflation to 2%. However, achieving an inflation rate of 3% may be accomplished with a considerably smaller increase in unemployment to 4.6%, resulting in the loss of 1.7 million jobs.
Joe Quinlan, head of market strategy at Merrill & Bank of America Private Bank, stated, "If the Fed is hell-bent on achieving 2% inflation, then this could necessitate additional rate hikes and a higher terminal rate than what is now anticipated." It is possible that excessive monetary tightening has precipitated a severe economic and earnings recession in the United States.
However, Quinlan also anticipates a more optimistic outcome. If inflation continues to decline toward 3 percent and Fed members "take their time" instead of pressing the issue, he anticipates a market rally.
"I wouldn't be surprised if the new Fed inflation target in approximately two years is somewhere between 3% and 3.5%. This is within the realm of possible and acceptable to all parties."
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