San Francisco Fed President Mary Daly indicates the central bank is in a 'wait-and-see' mode, with markets correctly pricing in a 'higher for longer' interest rate environment where holding steady is the most likely outcome.
Despite a rise in short-term consumer inflation expectations, Daly argues that medium and long-term expectations remain well-anchored, supported by wage growth consistent with the 2% target and businesses' inability to pass on full costs.
Geopolitical conflict and the resulting oil price shock are identified as the primary risks, but the current base case is that the shock will be temporary and the Fed can 'look through' it without overreacting.
Daly discusses potential future changes to Fed communication and balance sheet policy, suggesting a move towards scenario-based analysis over 'false precision' and a deliberative approach to operational frameworks.
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Concerns Raised
A prolonged geopolitical conflict could cause energy price shocks to spill over into core inflation.
Persistently high inflation prints could eventually cause medium and long-term inflation expectations to become unanchored.
The risk of policy error by either overreacting to temporary shocks or underreacting to persistent inflation.
Opportunities Identified
Inflation expectations remaining well-anchored, which allows the Fed to be patient and avoid overly restrictive policy.
A swift resolution to geopolitical conflicts could lead to a drop in oil prices, providing a tailwind for disinflation.
The underlying economic dynamics of a stable labor market and resilient businesses could guide inflation back to 2% without a significant downturn.