Monetary Policy & Inflation | US
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Summary
- A series of regional Fed research notes highlighting upside risks to inflation reflect the FOMC consensus.
- The risks of a second Donald Trump presidency have been rising, which supports no Fed cuts in 2024 because of higher 2025 inflation risks.
- This year the Jackson Hole symposium will be about monetary policy transmission, which the Fed is more likely to find wanting rather than strong.
Market Implications
- I do not expect the Fed to cut in 2024, against the market expecting 1.8 cuts by December.
Regional Feds Highlight Rising Inflation Risks
At the 12 June FOMC presser, there was strong consensus on the need for further good inflation data before the Fed could consider cutting. The consensus is reflected in the narrow range of 2024 dots, FOMC members’ public speeches, and in a series of research notes from the regional Feds (Table 2). These notes highlight upside risks to inflation and suggest ‘more’ good inflation data could mean much more than ‘a few more months.’
A recent Boston Fed note highlighted significant shelter cost disinflation may not come until 2025 (Chart 4).
Meanwhile, a recent St Louis Fed note studied how quickly monthly inflation can accurately predict annual inflation. It ran a simulation and concluded that if core inflation fell to 2% and remained there, it would take nine months of data for the 95% confidence interval for core PCE to fall below 3%. I think, should actual inflation fall to 2%, the Fed would be unlikely to wait nine months before cutting. Nevertheless, the note highlights ‘a few more months’ of good data is unlikely enough for the Fed to cut, especially against the backdrop of a strong economy (Charts 3 and 9 to 12).
Finally, a note from the Atlanta Fed highlighted upside risks to wage inflation (Chart 6). It stressed the abnormally low real wage growth in the recovery, which it attributed to employers trading working from home (WFH) against lower wage growth (I think immigration also contributed). It further showed businesses did not expect slower wage growth in 2024 than 2023, which is consistent with the authors finding adoption of WFH has largely played out. One of the authors, in a separate Wall Street Journal column on the same subject, concluded, ‘The Fed shouldn’t bet on more good luck. The wage-growth restraint associated with remote work is largely played out. The lesson? Good policy must finish the job of controlling inflation.’
Political developments are also pushing the FOMC to wait and see this year.
Political Risks Increase Fed Caution
Recent political developments have likely increased Fed caution. Trump’s May trial has seen a sharp increase in the campaign fund raising, which was twice as high as President Joe Biden’s campaign in May (Chart 7). Since then, Trump’s guilty verdict seems to have further increased contributions. Furthermore, following the first presidential debate, Trump’s odds of winning and polling average have shot up (Chart 8).
Since the debate, bonds have sold off sharply, which is consistent with Trump implementing reflationary policies, in an economy already at full employment.
The FOMC likely shares market views on the impact of Trump’s policies on growth and inflation. In a recent speech, Governor Bowman listed the ‘risk of additional fiscal stimulus that could add momentum to demand.’
Because the Fed cannot change policy quickly (for instance, in 2022 it waited until the end of QE to start hiking), it must preposition itself to manage a steep increase in inflation risks should Trump win the presidential election. Therefore, to preserve policy optionality, the Fed is likely to move to no 2024 cut in the September dot plot. This would allow it to move quickly to a neutral bias if Trump wins.
The bottom line is the Fed is unlikely to cut in 2024 if it sees a large risk of inflation accelerating in 2025.
Jackson Hole to Focus on Policy Transmission
The Kansas City Fed has published the theme of Jackson Hole, to be held on 24-26 August, ‘Reassessing the Effectiveness and Transmission of Monetary Policy’. The Fed will publish the details a few days before the actual seminar.
Growth resiliency since 2022 suggests Fed tightening has not been transmitting to the real economy, a theme I will explore ahead of Jackson Hole (Charts 13-16).
Market Consequences
I still expect no cut in 2024 against the market pricing 1.8 cuts.
Current Fed Macroeconomic Forecast
Recent FOMC Comments
Disinflation Still Stalled
Political and Economic Risks Are Rising
Fed Tightening Transmitting Poorly
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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
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