US Monetary Policy May Not Be Strong Enough to Bring Down Inflation to Fed's 2% Target

(MENAFN- Zentury Media )

The ongoing high inflation in the US has raised worries about whether the Federal Reserve's current monetary policy is effective in lowering consumer price increases. Concerns were particularly highlighted by Dallas Fed President & CEO Lorie Logan, who openly questioned if the current policy measures are strong enough to meet the central bank's inflation target of under 2%.

Logan's sobering assessment comes as the latest inflation data highlights an alarming lack of progress, with key gauges like the core PCE price index continuing to run well above 2% despite the Fed's most aggressive interest rate hiking campaign since Paul Volcker's inflation-slaying efforts in the early 1980s. As reported by CNN, the core PCE index rose 4.6% annually in March, more than double the Fed's goal.

Resurgent price pressures

Key US inflation measures, which seemed to ease at the end of 2022, have picked up speed again recently. This trend has wrongfooted economists and policymakers alike. Not only has the core PCE index retraced higher, but the stickier headline CPI also hit a stubbornly high 5% yearly rate in March.

The resurgent price pressures have blown away forecasts for a steady downward inflation trajectory in 2023. This brutally undermined the more assured narrative Fed Chair Jerome Powell struck earlier this year that the long-awaited disinflation process was finally underway across the US economy. Policymakers have rapidly reverted to a more cautious communication stance, warning that the path back to the Fed's 2% inflation target is now highly uncertain.

Various factors have been cited for the upside inflation surprises, ranging from structural stickiness in key sectors like housing and labour market strength keeping a floor under wage growth. More surprising drivers included impacts from policy decisions like the Biden administration's student debt relief plan and changes in how medical services inflation is calculated.

Despite the Fed's aggressive rate hikes, inflation remains stubbornly high and could erode consumer purchasing power. The combination is a recipe for deep cuts in discretionary spending that could impact various sectors of the economy. While essential goods and services remain a priority for most Americans, non-essential expenses like entertainment and leisure may face cutbacks.

This could especially affect industries heavily reliant on consumer discretionary spending, such as providers of food delivery, online casinos or video streaming services. These sectors could experience a slowdown in consumer demand if inflation continues to outpace wage growth.

Duelling policy outlooks

At the core of the policy divide is the balance between the urgent imperative of reining in stubbornly high inflation against the looming risks of overtightening into a more severe economic downturn and inflicting excessive economic pain.

Recent data offered temporary relief that the US economy managed to avert an outright recession over the opening months of 2023 thanks to resilient consumer spending holding up better than feared. However, the lagged impacts of the Fed's most aggressive tightening of monetary policy since the 1980s cycle are still working their way through the real economy.

With mortgage rates lurking above 6% and broader financial conditions still tightening, the consensus among forecasters is for growth to slow more palpably from the second half of 2023 and into 2024 as higher borrowing costs increasingly curb activity. Getting that calibration correct to cool inflation sufficiently without crashing the economy now looms as the pivotal judgement call facing policymakers.

Squaring the circle on policy path

Unsurprisingly, the highly uncertain inflation dynamics have fuelled increasingly fractious internal debates among Fed policymakers over the degree of monetary policy restraint required going forward. Logan's latest strikingly hawkish remarks reflect a shift in sentiment among several regional Fed presidents who now appear to favour pushing rates higher.

While doves like Minneapolis Fed President Neel Kashkari continue to warn loudly of the economic growth risks from an overly aggressive rates path, even centrist figures like influential Governor Philip Jefferson have been forced to acknowledge that progress on inflation remains "disappointingly slow". Jefferson's still relatively sanguine outlook assumes a return to the 2% target within a "reasonable" timeframe under the current rates trajectory.

Plainly, such assessments are at odds with the view espoused by Logan and some other hawkish Fed policymakers like Richmond's Thomas Barkin. For businesses and households, the increasingly muddy outlook raises the likelihood that borrowing costs and overall financial conditions may need to be kept restrictive for longer in order to definitively subdue stubborn inflation pressures.

While expenditure on essentials will remain the priority for consumers, discretionary outlays across areas like entertainment, hospitality, and non-essential retail face sustained headwinds from elevated inflation and slowing growth. As underscored by companies citing anaemic demand and subscriber losses amid intense cost-of-living pressures, with leisure spending on categories like food delivery services, online casino games and video streaming appearing especially vulnerable.

Market awaits fresh fed policy signals

Ultimately, much now hinges on the guidance delivered from the Fed's upcoming policy meeting on May 2nd-3rd. With growing acceptance that the long-promised disinflation process has stalled, markets will be laser-focused on any hints that the central bank is resetting towards a more restrictive policy stance.

The meeting statement, updated economic projections and Chair Powell's press conference remarks will be parsed for any hawkish pivot that could foreshadow lifting the terminal Fed funds rate peak above the 5.1% level outlined in March forecasts. While undoubtedly reiterating its overarching focus on taming inflation, any messaging amplifying concerns over the lack of progress risks catalysing expectations for higher rates ahead.

Conversely, the Fed sticking to its prior forecasts of inflation continuing to cool over the policy horizon could cool rate hike pricing – although it seems the central bank is rapidly losing credibility on that front given the continuing upside inflation misses.

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