The Fed has to crush consumer demand with much higher rates if it wants to get inflation under control, Bank of America says

• Americans' strong spending is keeping inflation elevated and sticky, which makes the Fed's job harder.
• The Fed will have to employ more interest rate hikes to crush demand and tame inflation, Bank of America said Monday.

Americans' spending spree is keeping inflation elevated and sticky, meaning the Federal Reserve must crush consumer demand with more interest rate hikes that will likely induce a recession, according to Bank of America.

In a Monday note, analysts explained that the Fed is unlikely to reach its 2% inflation target unless it leans into much more interest rate hikes. The odds of a downturn are high in that scenario, they maintained, because the non-consumer sectors of the economy already look weak.

"The strength in the January activity and inflation data suggests that the Fed might have to hike considerably further to find the point of pain for the consumer," BofA analysts wrote. "Right-tail risks to the terminal rate are growing."

Economic data released Monday showed durable goods orders declined more than expected in January, though core orders rose 0.7% versus estimates for a decline.

Last month, too, retail sales jumped 3%, overshooting the expected 1.9% increase. And consumer prices climbed 6.4% while producer prices increased 6%, with both figures clocking in above expectations.

Meanwhile on the supply side, shocks peaked in early 2022, though they haven't fully eased yet, BofA said. At the same time, while disinflation is emerging, there haven't been signs of obvious deflation just yet.

For prices to fall meaningfully, goods demand has to ease, the analysts noted.

"The demand impulse for core goods inflation has faded considerably as spending has rotated back to services," analysts wrote. "Supply-driven core goods inflation is also declining due to supply-chain normalization. But supply shocks would have to reverse for the long anticipated deflation in core goods prices to play out. This seems some ways away, with the 0.5% rise in core goods prices in January wiping out the price declines in 4Q 2022."

The Fed minutes release last week spooked investors, and it not only sparked a sell-off in stocks, but expectations for the Fed's terminal rate jumped, as DataTrek Research highlighted Monday.

"A week ago, Fed Funds Futures gave 31 percent odds that policy rates would end the year higher than the FOMC's December 2022 Summary of Economic Projections guidance of 5.1 percent," DataTrek cofounder Nicholas Colas wrote in a note. "Now, those odds are 63 percent."