The Federal Reserve has a lot of tightening to do if it wants to bring inflation under control, which is why Stephen Roach thinks that the US economy is in a state of stagflation.
Speaking to CNBC on Thursday, the former Morgan Stanley Asia chairman said the inflation problem is widespread and likely to last for a long time.
As the Fed takes aggressive action to combat inflation, investors are becoming more concerned about the risk of an economic downturn. El-Erian, a top economist, said this week that he sees a toxic mixture of a stagnant economy and rampant inflation as unavoidable for the US.
Two years ago, Roach warned of a 1970s-style stagflation. He was worried about supply-side pressures, but now he is worried about demand. The supply chain has been affected by the war in Ukraine and the COVID-zero policy of China.
The Fed has a lot of tightening to do, and the markets are not even close to discounted.
He said that it underscores the deep hole that Powell is in.
In May, Fed Chair Powell and fellow policymakers raised interest rates by 50 basis points, the biggest increase in 22 years. The central bank said that rate hikes would follow.
The Consumer Price Index, a closely watched measure of inflation, climbed 8.3% in the year through April, the highest inflation since the 1980s.
Roach thinks inflation will stay above 5% for the rest of the year, despite the argument that it will peak and fall back. Powell and the Fed will have to go a lot faster as that would suggest an undershoot.
The fed funds rate ends the year at 3.30 if he does 50 basis points at the next five meetings. Roach said that that is still nearly 2 points below what he thinks the inflation rate will be.
50 basis points doesn't cut it. He said that by ruling out something larger than that, he sent a signal that his hands were tied.
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