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Bullard Knows The Fed Is Losing Control of Inflation Expectations

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The Fed is “on the precipice of losing control of inflation expectations,”: says St, Louis Fed President James Bullard.

What does he mean? Apparently, the lower the public’s inflation expectations over the intermediate-term, the easier it is for the Fed to keep inflation down. He continues: “That's why it is important for the Fed to take action today that's credible, that will keep inflation expectations low and stable.”

Our thoughts: Market movements often reflect sentiment before fundamentals. Markets function like a pricing-in mechanism. As we can see, conflicting opinions about the Fed’s capacity to do its job with regard to easing inflationary pressures are mixed. Hence, the volatility in the markets overall has shown a net increase in yields and a net decrease in equities.

What to watch out for: Economist consensus expects this Friday’s May Consumer Price Index report to show an 8.2% rise year over year, or 5.9% rise in core CPI; both slightly lower than April’s reading. The markets are likely to respond in a volatile fashion depending on whether the data indicate inflation has peaked or continues to surge.

Important for Fed to take credible actions to keep inflation expectations low, St. Louis Fed president says.

The Federal Reserve is in danger of losing control of how much inflation American households are expecting, said St. Louis Fed President James Bullard on Wednesday.

“I think we’re on the precipice of losing control of inflation expectations,” Bullard said, in a speech to the Economic Club of Memphis.

“That’s why it is important for the Fed to take action today that’s credible, that will keep inflation expectations low and stable,” he said.

The Fed watches inflation expectations closely. Although difficult to measure, a basic tenant of Fed policy is that keeping inflation expectations low and stable will make it easier to bring inflation down.

Bullard presented a chart with three measures of short-term inflation expectations moving higher.

Source: MarketWatch

Inflation has surged over the past year as the U.S. economy has recovered from the pandemic. The Fed’s favorite inflation measure, the personal consumption expenditure index, was running at a 6.3% annual rate in April, well above the Fed’s 2% target.

In a subsequent interview with reporters, Bullard said that inflation expectation measures over one and two years are a better gauge of inflation expectations and are “pretty high.”

Longer-run inflation expectations are misleading because they just signal that markets and survey participants have some faith that the Fed will do “the right thing and get inflation under control.”

“I think it is more the one-year, two-year and three-year horizons that you might want to worry about for right now,” he said.

Bullard said the Fed has a “good plan in place” to raise interest rates by 50 basis point moves in both June and July and start to reduce the central bank’s balance sheet.

Asked if he favored a “pause” in September, Bullard said he wanted the Fed “to move more quickly than we have in past tightening cycles.”

“It seems to me we want to move as quickly as we can…to get downward pressure on inflation and make sure we keep inflation under control so we don’t have a decades long problem on our hands,” he said.

Read: Fed’s Bostic on what’s behind his call for a September pause

Bullard said he would like to get the Fed funds rate up to 3.5% rate by the end of the year.

“I’m one who thinks that a good chunk of what we’re observing in terms of inflation is more persistent and will require concerted action on the part of the central bank. I would some

If the Fed hikes interest rates by 50 basis points at both the June and July meeting, as most Fed officials support, the Fed’s benchmark rate will be in a range of 1.75% to 2%.

Stocks DJIA, -0.46% SPX, -0.68% were down Wednesday but off lows on concerns of persistent inflation. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.035% rose to 2.94%.

Orginally published by Greg Robb on MarketWatch.

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