The U.S. Federal Reserve Board may well overdo its current round of monetary policy tightening, warn TD Bank economists in a new report.

TD Economics says that the Fed is nearing the end of the current tightening cycle. “While the inflation risks are certainly present, inflation itself remains very well-contained. Overall economic growth has been proceeding at a modest clip – close to the economy’s long-run potential rate, despite the swings and bumps from one quarter to the next. And, the level of the Fed funds rate is no longer in stimulative territory – the Fed’s initial task of bringing its Fed funds rate back to neutral is complete,” it says.

“On this side of the border, the Bank of Canada may have further to go than the Fed, but even then, the end of the tightening run is still not far away,” TD predicts. “Although the Bank of Canada’s overnight rate is some 100 basis points below the Fed funds rate, the Canadian economy is still adjusting to the stronger Canadian dollar – and that justifies a peak below neutral. Meanwhile, growth has been running close to potential on this side of the border as well. And, inflation is certainly not a problem.”

TD’s call is still for a 4.75% Fed funds rate, “and given the amount of tightening that the Fed has already put into place, we also believe that a pause at this stage would be the better policy outcome. Nonetheless, given the recent strength in U.S. economic indicators, the odds are high that the Fed will overshoot that level,” it cautions.

“The problem is that monetary policy is not a high-precision surgical instrument. It’s more like a sledgehammer – it gets the job done, but often in a less-than-elegant way,” it says, noting that monetary policy operates with a lag, and that lag tends to be long and variable.

The bank indicates that the risk of an overshoot is not as high in Canada as in the U.S. “First, rates are expected to peak at lower levels – 75bps lower according to our base-case view, which is not inconsequential. The Bank of Canada will remain cognizant of the dampening effects of the stronger currency. But perhaps most importantly, the housing market – which we see as the likely spark for the U.S. slowdown – is nowhere near as much of a risk in Canada as in the U.S., and will not exert the same drag on consumer spending. And, obviously, the Canadian economy is not saddled with the same imbalances that prevail in the United States.”

“Although the Canadian economy will slow as the U.S. slowdown takes hold – which could well lead to a rate cut or two in Canada as well – we are not dealing with quite the same animal on this side of the border,” it concludes.