Fed Voting Committee Member Daly: Inflation is not the only risk, policy must "show caution"

2024 FOMC voting member and President of the Federal Reserve Bank of San Francisco, Daly, stated on Monday that the Federal Reserve must "exercise caution" in controlling inflation and avoid prematurely declaring victory over it. As the U.S. labor market is approaching a turning point, further cooling of the labor market could lead to an increase in the unemployment rate, with the increasing risk of such an outcome.

During her speech at the Federal Reserve Club of San Francisco, she said:

"We must continue to work tirelessly to fully restore price stability while avoiding the painful disruptions to the economy. Although we still need to make more efforts to reduce inflation, inflation is not the only risk we face, and we also need to pay attention to the labor market."

She pointed out that further reducing inflation may require curbing consumer demand to bring the inflation rate back to the Federal Reserve's 2% target, which could put pressure on the labor market. Despite the current unemployment rate of 4% being below the long-term sustainable level and the labor market conditions being good and no longer "bubbly," a slowdown in the labor market could lead to an increase in the unemployment rate, as companies would need to adjust not only job vacancies but also actual job positions. To prevent this scenario, the Federal Reserve must maintain a "high degree of vigilance and openness."

Earlier this month, the Federal Reserve kept interest rates in the range of 5.25%-5.5% since July last year and hinted at possibly only one rate cut this year instead of the expected three cuts in March. Last week, several Federal Reserve officials emphasized the need for more evidence of cooling inflation before cutting rates. Policymakers have kept rates at a 23-year high for nearly a year, and they do not seem eager to cut rates. On Monday, Daly did not disclose how many rate cuts the Federal Reserve might need (if any) to address the dual risks of high inflation and rising unemployment.

Furthermore, Daly urged policymakers to remain vigilant, stating that current monetary policy must be "condition-based" and prepared for various possible economic outcomes. If inflation declines more slowly than expected, Daly stated that maintaining rates for a longer period would be appropriate; or if inflation falls rapidly or the labor market shows unexpected weakness, a rate cut may be considered. She said:

"If we continue to see inflation gradually decline and the labor market slowly rebalance, then we can achieve policy normalization over time as many expect. There is currently no evidence that stagflation and recession will occur in our future."

Additionally, investors are most concerned this week about the Federal Reserve's preferred inflation measure—the Personal Consumption Expenditures (PCE) price index report on Friday, which recorded a 2.7% increase in both March and April, up from 2.5% in February and January. However, according to economists' forecasts, the latest data may show that the index did not rise at all from April to May. Daly stated:

"The fluctuating inflation data so far this year has not inspired confidence. While recent data suggests a slowdown in price growth, which is encouraging, it is difficult to know if we are truly on track to achieve price stability. **”