Entrenched Inflation Forces Fed Hikes
Five years of above-target inflation increases the risk that higher inflation becomes entrenched in wage and price-setting behavior, requiring more aggressive Fed tightening to reverse
Attention is building fast — up 4pp of coverage share over the last 3 days, now 4.2% of US10Y coverage.
Five years of inflation running above the Fed's 2% target has raised concerns that price pressures may become embedded in wage and price-setting behavior, requiring the central bank to pursue more aggressive tightening than would otherwise be necessary. The persistence of above-target inflation despite previous policy efforts suggests that inflation expectations may be drifting higher and becoming harder to reverse.
When inflation remains above target for extended periods, the risk of de-anchoring inflation expectations increases the structural level of real rates required to restore price stability, which can keep Treasury yields elevated for longer than markets initially anticipate. This dynamic creates a persistent headwind for risk assets and extends the period during which capital flows favor fixed income over equities.
Mainstream financial press is carrying this — attention has broadened beyond specialist outlets.
"In July, US inflation fell by 0.1 percentage point to 3.4 per cent but the rate has now remained above the Federal Reserve's 2.0 per cent target for more than five years."
"Even as inflation has cooled after spiking in May and June from higher gas prices, it remains above the central bank's 2% target. Politics are adding to the Fed's credibility problems."
"Even as inflation has cooled after spiking in May and June from higher gas prices, it remains above the central bank's 2% target. What many economists and Wall Street analysts are hoping for is a clear signal on how he thinks the Fed should handle the stubbornly elevated inflation."
"US inflation held steady at 3.7% in July, well above the Federal Reserve's 2% target for the 65th straight month, and the unexpected pause in the decline from a recent war-induced peak is likely to intensify the central bank's debate over whether interest rates should be lifted or held steady."
"The above-forecast headline print gave a modest lift to expectations that the Fed may raise interest rates as soon as next month. Fed funds futures prices reflected about a 40% probability of a rate hike at the central bank's September 15-16 meeting after the report, versus about 36% immediately before."
"The personal consumption expenditures price index, which the Fed uses as its preferred forecasting tool, increased a seasonally adjusted 0.2% for the month, putting the annual inflation rate at 3.7%, the Commerce Department reported Wednesday. Both were 0.1 percentage point above the Dow Jones consensus."
"Inflation remains above the Federal Reserve's target. Deutsche Bank's historical analysis found that consumer inflation above 3% has typically been associated with more than 100 basis points of tightening during the first year of Fed hiking cycles."
"The longer inflation is stuck here, the more likely it becomes embedded, which means that the disinflation doesn't materialize, which means the 2% target isn't credible, and restoring the 2% takes more work the more inflation is embedded."
"With inflation stubbornly elevated above the Fed's 2 per cent target for more than five years - compounded by the Iran war since February - monetary policymakers are increasingly considering lifting borrowing costs. Investors are betting they will announce one before the end of the year, with some eyeing at least two."
"Energy shocks since the U.S.-Iran war began at the end of February and serious questions about the Fed's inflation-fighting credibility have rattled the bond market. Inflation has been above the Fed's 2% target for more than five years."