The Fed pursuing 2% inflation is an 'absolute trap' for the economy, 40-year market veteran says
- The Fed's 2% inflation goal is an "absolute trap," according to 40-year market veteran Barry Knapp.
- Knapp pointed to tightening credit conditions, suggesting more tightening from the Fed could cause a recession.
The Federal Reserve is chasing its goal of getting inflation down to 2% by aggressively raising interesting rates, but that's leading the economy into a "trap," according to 40-year market veteran Barry Knapp.
The long-run target of the US central bank is unrealistic and some of the recent bank failures could end up doing the Fed's job of tightening financial conditions anyway.
"The whole 2% target is an absolute trap," The Ironsides Macroeconomics founder said in an interview with CNBC on Tuesday.
The economy is battling an oncoming credit crunch, with banks expected to pull back on lending after weathering major volatility stemming from rapidly rising interest rates. Banks have already tightened lending the most they ever have on record, according to data from Morgan Stanley, and small businesses lending is the tightest it's been in 20 years, per the latest national survey.
Bank deposits could fall by 11% in total, Knapp said, citing an estimate from Cato Institute's Mark Calabria. That reflects a major tightening in financial conditions, he said, calling the Fed's expected 25 basis-point rate hike this week "ridiculous."
Central bankers have raised interest rates aggressively in the past year to bring down inflation. But high rates risk overtightening the economy into a recession – and the risk of a downturn has been amplified by the tightening of credit conditions stemming banking turmoil.
"If credit drops that much, we've got a real, huge economic problem on our hands. The market is telling you, in terms of forward yield curves, that they expect the Fed to make a mistake," Knapp said, pointing to bond market futures pricing in a likely recession this year.
Some economists have argued that the Fed needs to press forward with rate hikes, given that inflation is still well-above the Fed's target, clocking in at 5% in March. But elevated inflation isn't necessarily a hindrance to the economy, Knapp said, pointing to 3%-4% inflation in the early 90s, years when the economy expanded and benefited from a huge boom in business spending.
Inflation will drop to 3% by June, Knapp predicted, agreeing with other market commentators who say the Fed should wait to see the full effect of tightening from banking turmoil before raising rates further.
Investors are pricing in an 86% chance the Fed will hike rates another 25 basis-points at the end of the policy meeting on Wednesday, per the CME FedWatch tool.