Rising inflation expectations! Federal Reserve Governor Bauman says the "struggle" is not over yet

Federal Reserve Governor Bauman continues to focus primarily on the inflation-fighting part of the Fed's dual mandate, unlike many colleagues who are more focused on the development of the U.S. labor market. It was this concern that led her to cast the only dissenting vote when the Fed decided to cut its target interest rate by 50 basis points on September 18. Bauman was more inclined to a modest 25 basis point cut at the September meeting of the Federal Open Market Committee.

Since July 2023, the Fed has kept the federal funds rate target between 5.25% and 5.5% in an effort to curb decades of high inflation. Speaking at the 2024 Kentucky Bankers Association Annual Meeting in Hot Springs, Virginia on September 26, Bauman stated that the fight against inflation is far from over.

Bauman said, "Despite the continued strength of the U.S. economy, inflation remains a concern, and I am more inclined to a modest policy rate cut." The latest core personal consumption expenditure (PCE) price index showed a 2.6% year-on-year increase in July, which, although lower than earlier this year, Bauman still believes is above the Fed's 2% annual target and "unsettling."

Bauman further pointed out that the upside risks to inflation still exist. Global supply chains remain vulnerable to labor strikes and geopolitical tensions, which could have inflationary effects on food, energy, and other commodity markets. In addition, expansionary fiscal spending and increasing housing demand, especially the long-standing shortage of affordable housing, could exacerbate inflation risks.

In the U.S. labor market, although the hiring boom after the COVID-19 pandemic has cooled down, recruitment and wage growth have slowed, job vacancies have decreased, and the unemployment rate rose to 4.2% in August, Bauman believes this is still below her estimate of full employment and does not require emergency assistance. She noted that wage growth remains strong, consumer spending remains robust, and gross domestic product (GDP) growth remains resilient, contrary to claims of a significant weakening or fragility in the economy.

Bauman, like other Fed officials, believes it is time to start cutting rates now, but she leans towards starting this process slowly. She is concerned that a sharp rate cut could signal Fed panic about the economic outlook. In addition, she does not want the market to expect further significant rate cuts in the future, as this could lead to a decline in bond yields, financial conditions becoming looser than policymakers expected, and potentially reigniting inflation.

Meanwhile, consumer expectations for future inflation have also risen. According to the latest consumer confidence survey, the 12-month inflation expectation for September rose to 5.2%. Investors and analysts are also wary of the Fed potentially shifting its focus to the labor market too early, leading to a resurgence of inflation issues. The recent rebound in commodity prices is also one of the reasons for the rebound in inflation expectations. The U.S. benchmark West Texas Intermediate crude oil price has risen from above $65.75 per barrel in early September to above $71.

However, despite the rise in inflation expectations, analysts still believe that the overall trend of inflation is downward, the question is how fast. Gennadiy Goldberg, interest rate strategist at TD Securities, pointed out that there is no evidence of another potential wave of inflation on the horizon T. Rowe Price's capital market strategist Tim Murray said: "They (the Federal Reserve) are more willing to use all means to avoid an economic recession, but going down this path definitely means there will be inflation. Investors may also be guarding against a repeat of the 1970s, when the Federal Reserve prematurely declared victory over inflation, only for inflation to return. Murray said he does not want history to repeat itself. Although this outcome is unlikely, it is worth keeping in mind