BofA drops stunning warning about Fed rate hikes

Bank of America has maintained its forecast for two more Federal Reserve rate hikes this year, while raising a critical question about whether even a 75 basis point increase will be sufficient to bring inflation back to the Fed's 2% target. In a client note, the bank acknowledged the robustness of the nominal economy, which increases the risks of inflation persistence but reduces the risks of a recession from rate hikes.

However, if supply shocks prove persistent, the Fed may face a difficult decision between an extended inflation overshoot and a hard landing. The unanimous Fed decision on September 16 to raise rates by 25 basis points marked a hawkish shift in monetary policy, with multiple Fed policymakers anticipating at least one more hike before the year's end.

Despite the Fed's shift, some analysts argue that the central bank did not need to hike in September, as inflation was already close to 2% and the overshoot was primarily due to supply disruptions. BofA believes that underlying inflation has remained around 2.5% due to insufficient policy tightness. The bank sees the economy's resilience as changing the Fed's risk/reward calculus, emphasizing that robust nominal growth increases the risk of demand-driven inflation if the Fed does not tighten further.