Dom’s Quick Take: What Is Driving Brainard? 

Lael Brainard’s latest speech made a case for moving more slowly based on inflation prospects improving. She argued, ‘In light of elevated global economic and financial uncertainty, moving forward deliberately and in a data-dependent manner will enable us to learn how economic activity, employment, and inflation are adjusting to cumulative tightening in order to inform our assessments of the path of the policy rate’.

This really is a repeat of the Fed refrain since 2021 that inflation stabilization is around the corner.

For instance, she says ‘core goods have been expected to return to something closer to the pre-pandemic trend of modest disinflation. Disinflation in core goods would help to offset the inflationary pressures in services.’ Interestingly, she does not say ‘I have been expecting’, which does not convey much confidence in that forecast. This could reflect that the latest data shows core goods stabilizing rather than falling (Chart 1). As a result, Brainard’s comments come across as wishful thinking.

Why then is Brainard alluding to a slower pace of hikes despite a lack of confidence in a rosy inflation outlook? I suspect it could reflect concerns over market functioning, especially the Treasury market, and rightly so. The ongoing gilt volatility event follows the US Treasury market volatility of March 2020, which was also large enough and potentially destabilizing enough to prompt the central bank to step in as market maker of last resort. This points at underlying weaknesses in market pipes and/or hidden leverage.

Currently the Fed is slamming rather than stepping on the brakes. In view of ongoing bond market liquidity tightening, it would be prudent to slow to, e.g., 50bps in November and go back to 75bp in December. But the Fed is so behind the curve that its hands are tied: with the current labour market data, even the FOMC doves agree that they want to frontload rate hikes, and 75bp seems to have already been agreed for 2 November 2022. In addition, 75bp also seems likely in December because even the doves have said that they would react to actual rather than expected inflation to decide when to pivot (for instance Cook). Between the November and December meetings, there will be one NFP, and two CPI prints, and it is hard to see how this data could show a very different inflation/labour market picture. Another 75bp in December could trigger another bout of market instability.

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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