Source: iStockphotoThe Federal Reserve is the proverbial bull in the china shop, prepared to create damage with higher interest rates to bring down the hottest inflation spell of the past 40 years.The first thing that will break is the financial markets, “as currently unfolding,” BMO Capital Markets economists Michael Gregory and Sal Guatieri said in a note Monday. Dow industrials fell into its first bear market in more than two years on Monday, joining the S&P 500 index and Nasdaq Composite which have already been in one; the dollar added to more than 20-year highs, wreaking havoc around the world; and lending conditions tightened further as more Treasury yields rose above or touched 4% — the level some see as sending shivers through investors.Financial markets failed to find positive momentum on Monday, adding to Friday’s weekly losses in U.S. stocks. Meanwhile, the 10-year Treasury yield reached its highest level since April 2010, at 3.878%, as 2- and 3-year rates climbed to 4.3% and 4.4% respectively.“Based on our in-house measure, financial conditions are set to carve 2 percentage points from U.S. GDP growth next year,” Gregory and Guatieri wrote. “This reflects the punishing effects of the mighty greenback, the angry bear market in equities, wider credit spreads and tighter lending conditions, and assumes another 150 bps (basis points) of Fed rate hikes and a 15% slide in house prices. At the very least, the financial clouds have the words ‘shallow recession’ written all over them.” They see the U.S. posting back-to-back declines in quarterly real GDP in the first half of next year, and the unemployment rate rising to 5% from August’s 3.7% level by late next year.Reached by phone on Monday, Guatieri, based in Toronto, said “we’ve already seen financial conditions come under undue pressure, with the S&P 500 down more than 20%, bond markets very weak, and corporate credit spreads widening significantly. It all points to a much weaker economy in the year ahead.” The BMO economists now see the Fed ending its rate hike campaign between 4.5% to 4.75%, three-quarters of a percentage point higher than they had previously expected. The additional 75 basis points in hikes will turn out to be the “straw that breaks the camel’s back,” to use another proverb. And the world’s largest economy “is past the point of rescue” as the Fed pledges to restore price stability at all costs, they said.
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