Bank of America warned that investors should prepare for the risk that the Federal Reserve raises its benchmark interest rate above 5%.
In a report on the 19th, BofA strategists including Mark Cabana and Meghan Swiber projected that the Fed could lift its policy rate back to the levels seen during the 2022-2023 tightening cycle, when the upper bound reached as high as 5.5%. The report said the market is still underestimating the Fed's terminal rate and advised investors to brace for higher two-year Treasury yields.
Interest-rate swap markets currently price in three more Fed increases, which would bring the effective federal funds rate to between 4.5% and 4.75%. The two-year Treasury yield stood at about 4.7% as of the 18th.
"The Fed does not currently view monetary policy as restrictive and is likely to keep raising rates until financial conditions tighten," the BofA team said in the report. "In that case, a flattening of the yield curve will clearly emerge," as short-term rates surge while long-term rates hold steady.
The report projected that the two-year Treasury yield could rise to 5.25%, its 2023 peak. It also noted that under the Taylor rule — a formula that calculates an appropriate policy rate based on how far inflation and economic output deviate from their targets — the federal funds rate should stand at about 5.3%. Still, the report expects increases in longer-dated Treasury yields to be limited, forecasting the 10-year yield will remain at its current level of 5% through the end of the year.
Aditya Bhave, a U.S. economist at BofA, maintained his existing forecast in a Sept. 16 report that the Fed will raise rates twice more this year, once each in October and December.
Fed Hawk Says Inflation Still Too High Across the Economy
Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said on the 20th that U.S. inflation is not simply a product of higher oil prices but remains excessively high across every sector of the economy.
Speaking on Fox News that morning, Kashkari said inflation remains too high even excluding highly volatile energy and food prices, though he noted those categories also matter when assessing where the economy is headed. The inflation Americans feel every day goes beyond oil prices and is showing up throughout the economy, including across the services sector, he said, adding that the Fed has the tools to bring it down.
Kashkari said the Fed's mandate is to bring inflation back to its 2% target, stressing that adjusting interest rates cannot reopen the Strait of Hormuz or lower oil prices. He also said he hopes to get some help from other parts of the government and other areas of the real economy.
Kashkari backed the Fed's unanimous decision last week to raise the benchmark rate by 0.25 percentage point. He was one of three officials who dissented at the July meeting of the Federal Open Market Committee, arguing for an increase when the Fed held rates steady, and is regarded as one of the central bank's leading hawks.
