• Economist Stephen Roach explained why stagflation is his base case for the US in a CNBC interview.
  • Markets aren't prepared for the massive tightening the Fed needs to do to tame inflation, he said Thursday.
  • "50 basis points doesn't cut it," he said, arguing the Fed will have to be more aggressive than it plans.

Economist Stephen Roach said stagflation is his base case scenario for the US economy, as the Federal Reserve has a massive amount of tightening to do if it wants to bring inflation under control.

Speaking to CNBC's "Fast Money" on Thursday, the former Morgan Stanley Asia chairman said the inflation problem is widespread and persistent, and is likely to last for a long time.

Investors have become increasingly concerned about the risk of an economic slowdown, or even recession, as the Fed takes aggressive action to combat inflation running at 40-year-highs. Top economist Mohamed El-Erian said this week he sees stagflation — a toxic mixture of a stagnant economy and rampant inflation — as unavoidable for the US.

Roach last warned of a 1970s-style stagflation two years ago, at the onset of the pandemic. At that time, he was worried about supply-side pressures, but now he's concerned about demand. This year, the war in Ukraine and China's COVID-zero policy have help clog up the supply chain, he noted.

"The demand side has really gotten away from the Fed, and the Fed has a massive amount of tightening to do," he said. "The markets are not even close to discounting the full extent of what's going to be required to bring the demand side under control."

"That underscores the deep hole that Jerome Powell is in," he added.

In May, Fed Chair Powell and fellow policymakers raised interest rates by 50 basis points, the biggest increase at one meeting in 22 years. The central bank signaled that similarly aggressive rate hikes would follow.

The Consumer Price Index, a closely watched measure of inflation, climbed 8.3% in the year through April, showing the highest inflation since the 1980s. 

Yale economist Roach disagreed with the argument that inflation would peak and fall back, and he believes it will stay above 5% for the rest of the year. Given that, Powell and the Fed will have to go a lot faster, as that would suggest an undershoot.

"Even if he does 50 basis points at the next five FOMC meetings in 2022, the fed funds rate ends the year 3.25. Again, that's still nearly 2 points below what I think the inflation rate will be," Roach said.

"50 basis points doesn't cut it. And, by ruling out something larger than that, he just sends a signal that his hands are tied," he added. "And I think the markets are uncomfortable with that conclusion."

Read more: A portfolio manager at billionaire investor Mario Gabelli's $41 billion firm says to buy these 27 stocks that have the pricing power to deliver returns as inflation soars

Read the original article on Business Insider