The first Wall Street bank to call for a recession in the US now sees an opportunity for inflation to fail to slow

Deutsche Bank, the first major bank to forecast a US recession in the current era of inflation, now sees an opportunity that price gains won’t falter nearly as much as forecasters or federal policy makers think.

Deutsche Bank DB,
“There is a real chance that the market is underestimating the chance that inflation is accelerating or not slowing down fast enough,” Tim Wessel, macro strategist, said in a phone interview on Wednesday.

His comments come as a few market participants – such as Rob Daley of Glenmede Investment Management in Philadelphia – warn that inflation could prove to be resistant to higher Fed rates in the second half of this year. Financial markets may be in a bad position for such an outcome, and if this scenario succeeds, investors and traders could be in for another round of turmoil similar to the one in the first half – with some seeing an conceivable increased risk that the Fed may lose control of inflation.

Read: What’s at stake for financial markets if investors get it wrong again in the second half

“If you look at the last 18 months of forecasts, they have all missed out in one direction – the downside – whether it’s by professional forecasters, or the markets, or the Federal Reserve. I see no reason why we shouldn’t think that everyone is underestimating the odds of a rally. inflation.

“Now we’re assuming we’ve missed out on some fundamental underlying change in inflation that we didn’t take into account, and now we see a real possibility that the market is underestimating the odds of inflation accelerating or not decelerating fast enough,” the York strategist said.

This idea is supported by inflation derivatives traders, who have had a track record of accurately forecasting inflation for most of the past year and have the most money at stake getting it right: They are now seeing nearly four more months of annual CPI readings of just under 9% , up from a nearly 41-year high of 8.6%.

Thursday’s data on the PCE, or personal consumption expenditures index, is expected to show a monthly gain of 0.4% for May in the core reading that excludes food and energy, based on the median expectations of economists polled by the Wall Street Journal. This is in line with the 0.38% m/m gain expected at Deutsche Bank.

However, it’s not the gains themselves that are a problem, but rather the likelihood that they will follow three consecutive months of 0.3% of core PCE readings on a monthly basis from February to April, as well as a 0.4% monthly reading in January and a 0.5% gain Monthly in December.

Policymakers are beginning to dip readings for PCE inflation from 2022 to 2024, in their latest forecast released on June 15. Professional forecasters are also looking for moderate inflation.

“Inflation certainly isn’t slowing as quickly as markets and the Federal Reserve had hoped,” said John Silvia, founder and CEO of Dynamic Economic Strategy on Captiva Island, Florida. “What we’re seeing is that constant price action is up, and the evidence is that input prices continue to Rising faster than people could have deducted from it.”

“Either the markets and the Federal Reserve accept a rise in inflation, or policymakers are really seeking to raise interest rates to combat inflation: Either way, this is bad news for the economy,” Sylvia, a former chief economist at Wells Fargo Securities, said by phone on Wednesday. “If the question is whether a hard landing is in the pie — two or three quarters of negative real economic growth, rising inflation and unemployment — the answer for me is ‘yes’.

With a series of consistently hot inflation readings, Wessel said the Fed “will continue to pick up slow growth.” That will translate into higher interest rates, flattening Treasury yield curves, increased volatility, underperformance of risky assets and widening credit spreads, he said.

Such moves “could happen any day and even once the next inflation prints, with interest rates exposed to a significant contrarian move, and any inflation numbers could move the needle,” said the Deutsche Bank strategist.

For now, the Fed is likely to “do whatever it takes to allow inflation expectations to go unchallenged, and ultimately win the battle. It’s just a matter of how painful it is,” Wessel said. A chance for policy makers to lose control of inflation and “I don’t want to rule out that possibility”.

Earlier this year, Deutsche Bank became the first Wall Street bank to predict a recession – a thesis that has since gained more credence. Revised data released on Wednesday shows that the economy contracted at a deeper-than-expected 1.6% annual pace in the first quarter. In addition, Federal Reserve Chairman Jerome Powell said there is no guarantee that policymakers can formulate a smooth landing for the US economy.

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