SAN FRANCISCO- Investors and economists expect the US central bank to respond “strongly and systematically” to changes in inflation and the labor market, according to research published on Monday by the San Francisco Fed that underscores the current sensitivity of financial markets to US economic data.
The Fed’s perceived responsiveness to economic data picked up notably in 2022, driven first by inflation data and, last year, by labor market data, based on the analysis of perceptions embedded in professional forecasts and in bond market moves published in the regional Fed bank’s latest Economic Letter.
The findings are in line with the Fed’s actual response to inflation, which rose in 2021 but did not trigger any interest rate hikes until 2022. They also track with the Fed’s reaction to labor market data, which weakened notably in the middle of last year and helped drive the Fed’s decision to cut the policy rate by a full percentage point starting last September.
The Fed’s target policy rate is currently in the 4.25 percent-4.50 percent range. Recent weaker economic readings, including a survey released on Friday showing business activity fell to a 17-month low this month, have helped firm up market bets on two quarter-percentage-point reductions to the policy rate this year.
Worries about stalling economic growth appear to be outweighing fears of a resurgence in inflation, also evident in recent surveys, at least as far as market bets on how the Fed will react with monetary policy.
Interest rate futures contracts are currently priced for the first Fed rate cut this year to come in June, with the second to happen as early as October.
Earlier, Federal Reserve officials said they are taking note of what they see as rising inflation risks and the uncertain impact of President Donald Trump’s trade, immigration and other policies.
On Thursday, several signaled they still feel that cooling US inflation will in time allow the US central bank to deliver further interest rate cuts; one said that current conditions call for holding rates steady, and gave no indication of when, or whether, she felt cuts would be needed.
“Going forward, I consider it is appropriate to hold the federal funds rate in place for some time, given the balance of risks that we face right now,” Federal Reserve Governor Adriana Kugler said on Thursday.
Inflation still has “some way to go” before reaching the Fed’s 2 percent target, she said, and while the labor market is healthy and the risk of it weakening has diminished, upside risks to inflation remain.
As for Trump’s policies, she said, the net effect will depend on the specifics.
Since taking office on January 20, Trump has delivered a steady stream of actions – or threats of them – to impose tariffs on goods from key U.S. trading partners, including China, Mexico and Canada.
Still unknown, Kugler and her fellow policymakers point out, is how broad and big they will end up being, whether other countries will respond with their own taxes on US exports, and to what degree consumers rather than intermediaries will bear the cost.
And while for now it appears tariffs could potentially push up prices, it is not clear by how much, she said, adding, “we will have to wait.”
Atlanta Fed President Raphael Bostic said his “baseline expectation” is for two quarter-percentage-point rate cuts later this year, but «the uncertainty around that is pretty significant … There›s a lot that could happen that could influence that in both directions.»
Bostic, who is not a voting member of the Fed’s rate-setting committee this year, told reporters in a call he did not think the U.S. economy is facing a new burst of inflation, and noted that a still-low 4 percent unemployment rate shows the labor market is healthy.
But there is, he said, both enthusiasm and “widespread apprehension” among businesses about how new import taxes, immigration rules, and changes to regulations will affect the outlook.
