At some point, the Federal Reserve may have to get more aggressive, raising interest rates above the neutral rate to slow down the economy, according to the latest CNBC Fed Survey.
Two-thirds of respondents to the CNBC Fed Survey expect the central bank will increase interest rates beyond neutral, acting explicitly to slow growth. The so-called neutral rate for fed funds is also the "natural" rate, the level where interest rates neither speed up nor slow down the economy.
For now, market pros expect the Fed to raise interest rates Wednesday by a quarter point and hike again in September, but they are divided over whether a third increase will come in December, according to the survey. There is similar agreement on two more hikes in 2019, but disagreement over a third. By the end of next year, the consensus sees the Fed raising rates to around 3 percent, and then ultimately going to 3.3 percent.
"The Fed continues to face a difficult challenge as it tries to calibrate interest rates over the coming quarters. The U.S. economy is late-cycle and being stimulated by large fiscal stimulus that will, over the next few years, push it close to full capacity utilization," wrote Kathy Bostjancic, head of U.S. macro investor services at Oxford Economics USA.
The survey also shows the economists, money managers and analysts surveyed see solid growth of nearly 3 percent in 2018 and 2019 and just a 13.8 percent chance of recession in the next year, the third-lowest reading since CNBC started doing the survey seven years ago.
The biggest threat is the president's protectionist policies. Some 58 percent approve or strongly approve of President Donald Trump's handling of the economy, but 60 percent see his trade policies as negative for U.S. growth.
"We finally have an economy that is running 'hot,' the culmination of a long recovery, plenty of global liquidity and stimulative fiscal policy. The challenge will be actually achieving a soft landing given the mounting risks due to trade tensions and accumulated global debt levels," wrote Constance Hunter, KMPG's chief economist.
For the first time in three months, the outlook for stock market gains for this year and next went up among the 38 respondents to the CNBC Fed Survey. They expect the S&P 500 to be at 2,848 at year-end, higher than the current level but still below its 2018 all-time high of 2,872. They see it reaching 2,946 by the end of next year. The S&P 500 was around 2,785 on Tuesday afternoon.
Their outlook for bond yields has leveled off at 3.23 percent for 2018 and 3.51 percent for 2019. This follows three straight months of increases that have added about 30 basis points to the consensus forecast for the 10-year yield. The outlook for stable yields coincides with a more stable outlook for inflation, seen rising no more than 2.45 percent his year.
Mike Englund, chief economist at Action Economics, doesn't see the Fed pushing much above neutral without much of a pickup in inflation.
"The Fed will be comfortable tightening until they've achieved a reasonable level of neutrality, with a 2-handle on the fed funds rate and a moderate pace of QE unwind. The Fed will likely be hesitant to push past that without clear evidence of inflation," he wrote.
— CNBC's Steve Liesman contributed to this story.