Bank of America (BofA) economists Aditya Bhave and Mark Cabana are concerned that the Federal Reserve, under the leadership of Chair Kevin Warsh, is setting the stage for a repeat of the aggressive rate hikes seen in 2022, potentially driving the federal funds rate above 5%. Their primary concern is Warsh's lack of transparent guidance regarding the Fed's 'reaction function'—specifically, what inflation gauges he prioritizes, how he defines underlying inflation, and his tolerance threshold for inflation deviating from the 2% target. This absence of clear communication creates uncertainty for investors, acting as a "tax on the economy" by increasing the risk premium demanded by investors, which then translates into higher borrowing costs across the board.
BofA argues that while markets don't need promises about individual rate decisions, they do require clarity on the Fed's coherent plan to return inflation to its 2% target. They cite a jump in inflation expectations following Warsh's July press conference as evidence of this lack of clarity. This uncertainty can lead to higher long-term Treasury yields, making borrowing more expensive for businesses and consumers, thereby cooling spending and investment even without aggressive benchmark rate hikes. The bank also notes that a healthy increase in yields should stem from confidence in the Fed's inflation control, not from heightened inflation expectations and a larger term premium signaling policy uncertainty.
Despite their concerns about the Fed's communication, BofA itself anticipates significant further tightening. The bank projects 75 basis points of rate hikes in 2026, delivered in 25-basis-point increments in September, October, and December. This would place the federal funds rate in the 4.25%-4.50% range, where BofA expects it to remain through 2027 and 2028. This outlook highlights a disparity between the market's need for clear communication and the anticipated aggressive policy actions.
