Monetary policy is a tricky thing.
There are examples throughout history of central banks making missteps and ending up with unintended consequences.
In recent years, many central banks have been forced to cut interest rates soon after raising them because their economy was simply not ready.
According to David Kelly, the chief global strategist at JP Morgan Funds, however, the real danger is the exact opposite but equally disastrous.
“The Fed is flying this plane and they’re aiming for a soft landing,” Kelly told Business Insider Friday.
“The problem is the people at the controls don’t know how to fly.”
Kelly is of the opinion that the economy is strong enough to sustain not just the rate hike from the Fed seen on Wednesday, but a brisk pace of rate hikes going forward.
The biggest concern — which even Janet Yellen herself has mentioned — is that the economy could be ready for rate hikes and that by going to slow the Fed runs the risk of letting the economy overheat. This could lead to a Fed-induced recession, which is clearly the worst outcome for the Fed.
Kelly also thinks the economy could overheat if the unemployment rate drops below “full employment,” thus causing wages to spike with inflation following shortly after. “There is an extreme risk that we get back to full employment before the interest rates get back to neutral,” said Kelly.
Pointed to the Fed’s own economic outlook, Kelly noted that in the past three years GDP growth has been between 2.2% and 2.4% while the unemployment rate has fallen by around 1% annually. In its latest release, the Fed still expects GDP to stay in the same range but for the unemployment rate to only drop only .2%-.4%.
“That is just a wrong forecast,” Kelly said. “The unemployment rate will come down more than the Fed expects and that will keep their feet to the fire for more rate hikes.”
And overall, Kelly thinks that the Fed is simply so afraid of upsetting the market with rate hikes that it will ultimately let the economy run too hot.
“In the past 5 tightening cycles, we usually see an [interest rate] increase of 2.5% per year,” Kelly said. “And now the Fed is saying they will move at 40% of the usual rate and the markets are assuming just 20% of that.”
And Kelly said he wouldn’t be surprised if the Fed capitulated to the market’s expectations and go at that slower pace. “This is a nervous Fed. It doesn’t take much for them to be pushed off their plan and reverse course.”
Though no matter what the Fed ultimately does, Kelly does not think there will be likely be a clean ending for the economy.
“All I would say is that every one should buckle up.”
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