Goldman Sachs Sees Risk of Higher Peak in Fed's Tightening Cycle

(Bloomberg) -- The U.S. Federal Reserve is almost certain to raise interest rates in June and there’s a risk that its tightening cycle will peak higher than currently forecast, Goldman Sachs economists said.

While the Fed will keep rates on hold this week, the U.S. economic growth outlook remains positive and “the inflation picture has firmed,” the economists, led by Jan Hatzius in New York, wrote in a research note. These developments and recent comments by Fed officials point to an “upbeat tone” in Wednesday’s statement and “we now see a 90 percent subjective probability of a hike in June, up from 85 percent previously,” they said.

A June rate increase would be the second this year and some economists see a risk that the Fed will tighten four times in 2018 rather than the three moves it has penciled in. The central bank has lifted its key rate by 150 basis points over the past two years, which Goldman said is almost half the 325-point trough-to-peak increase expected this tightening cycle.

However, the economists said a more “outcome-based” approach indicates the peak of the cycle could be higher than that.

They said the Fed’s challenge is to bring about a policy tightening sufficient to slow growth to a sustainable pace but not tip the economy into recession, and there is still little evidence that it is close to the halfway mark from this perspective.

“In fact, we estimate that only around a quarter of the required slowdown to a trend pace has occurred, and we don’t expect that picture to change quickly,” the economists said. “Partly reflecting this, we view the risks to our forecast of a terminal rate of 3.25 to 3.5 percent as tilted to the upside.”

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