Dreyfus and Mellon Chief Economist & Macro Strategist Vincent Reinhart joins Yahoo Finance Live to discuss the path for the Fed as investors await inflation data, recessionary risks, and the outlook for the U.S. economy.

Video Transcript

- Vincent Reinhart is Dreyfus and Mellon chief economist and macro strategist. And he joins us now.

Vincent, thanks for being here. Economists are looking for a more than 8% annual increase in that headline CPI. Is this going to be the peak in inflation?

VINCENT REINHART: Probably close to it. We learned this morning that gasoline prices were off on a weekly basis. As previously said, oil prices have come down some. And so we're going to be at or around near the peak.

But the important point to note is, any headline is going to say inflation is running at a 40-year high right now, because it is.

- Vince, you mentioned that it is a strong likelihood that we get 350 basis point rate hikes somewhat soon. What's the economic impact of something like that?

VINCENT REINHART: The Fed is engineering a tightening in financial conditions because it has to slow the growth in aggregate demand. That means that the increases in short-term interest rates-- because nobody actually transacts much at the overnight federal funds rate-- will get felt through the rest of the yield curve at longer maturities. It has and will increasingly make it harder to borrow on consumer loans, auto loans. Mortgage rates are at a recent peak. They're going to keep going up. That will tighten credit availability.

As interest rates rise, the discount rate on future earnings goes up, i.e. their present value goes down. Equity prices take a hit. And probably the exchange value of the dollar goes up. All those combined to tighten financial conditions, slow aggregate demand.

But importantly, what the Fed is trying to address is a direct hit to households, their confidence, and their expectations about inflation. They're going to want to reassure you as many ways as possible that inflation is anchored around their goal of 2%. And so being forceful at the beginning is essentially a demonstration of their credibility.

- Do you think even being forceful in the beginning is going to be enough, though, because as Fed Chair Jerome Powell has said repeatedly, monetary policy does act on a lag. Do you think the everyday consumer is going to really understand the implications of what the Fed is doing in the near term?

VINCENT REINHART: No. I think the Fed's got a tough job. The policy choice itself is difficult. Explaining itself is even harder.

Remember a couple things. Number 1 is, yes, tossing in a few 50-basis points and even more hikes over the next six meetings of 2022 will raise the nominal federal funds rate a lot. It'll still be negative in real terms. Inflation is running fast enough that the real policy rate will be negative well into 2023.

That doesn't actually sound like much monetary policy tightening. As you say, as Chair Powell says, monetary policy works with a lag. It's going to take a while before the interest-sensitive sectors of spending slow down some. So that does suggest that the Fed is going to have to be in for the long game.

But meanwhile, we have things that are hitting the economy pretty quickly. The coronavirus isn't going away, as you reported earlier. Oil prices are up considerably.

It's not just where they are now in terms of oil prices, it's where they have been. The increase in oil prices to $100 a barrel range is considerably higher than what households have known over the previous three years. That's a real spike. And that is disruptive to their spending plans.

So the Fed's doing something in slow motion in terms of its influence on the economy. But meanwhile, there are other faster moving forces.

- I mean, some economists on the street have started to predict a recession in the US later next year. But given what you were just mentioning, high oil prices, high gas prices, high food inflation, might get a CPI print tomorrow over 8% on the headline-- why wouldn't there be a recession this year at some point?

VINCENT REINHART: So the economy is a slow-moving boat. And we do have considerable momentum to spending. Just look at what GDP growth was in the fourth quarter and poised to be in the first quarter.

Is it possible? I would say it's probably closer to a coin toss that the economy will be moving into recession by the end of the year. How come? You listed a few-- the yield curve is inverted by many measures, oil prices are considerably higher, the Fed's tightening 7 out of the 8 last eight times the Federal Reserve went into a tightening spell, a recession followed. And we are getting close to full employment.

Trees don't grow to the sky. Something stops an economy from going well over its potential to produce. One of the things historically is recession.

So I think if you're looking over the next year and a half or so, you should think a recession is easily a coin toss. Could it happen a bit sooner? Sure.

And by the way, history always reads differently than it lived. Will historians in a couple of years be talking about the warning signs of the mid-summer recession that were missed in 2022? Possible.

- How much of a buffer do you think consumers have right now with their savings and with the tight labor market before rising prices do some of the Fed's job for it and bring down demand simply because consumers won't be paying these prices anymore?

VINCENT REINHART: Yeah. So you were really identifying a channel that makes some people a little bit more confident, particularly about the near-term path of consumer spending, which is more than 2/3 of overall aggregate spending. And that is, the government made significant discretionary payments to households over the past year and 3/4 associated with coronavirus relief.

By some measures, households have in the neighborhood of $2 trillion of excess saving. They can start working that saving down. And they are.

And that will be an important buffer. That buffer is important because the government is actually tapping on the brakes. The federal government's contribution to spending growth is actually a drag.

So that wherewithal is there in the form of excess saving. But it's going to eaten away by higher inflation. And also remember that inflation, particularly energy price inflation, is very unfair. It's a regressive tax. Lower income households without those buffers spend disproportionately more of their income on energy and food.

That's going to take a bigger bite out of those households who are more at the margin of getting by.

- Some great insights there. Vincent Reinhart, Dreyfus and Mellon chief economist and macro strategist and also former director of Federal Reserve Board's division of monetary affairs. Thank you so much this morning.