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The narrative on inflation is changing. Fed Chair Powell confirmed this.
He echoed what other current and former Fed members shared in recent weeks, and what recent data supports:
“Progress” (toward lover rates of inflation) is slowing.
In other words, inflation is no longer going down.
This raises two thoughts:
If inflation is sticky, can it be absorbed by the economy?
Is the neutral rate higher than previously expected?
The short answer on both is likely yes.
GDP growth has averaged 2.9% for about two years, enduring much higher rates of inflation.
- Granted, growth benefited from fiscal and monetary policy.
- Assuming the economy can sustain above average growth, inflation should be absorbed.
The good news is that the bond market still projects reasonable inflation rates 5 and 10 years out (at 2.3%-2.4%).
But that is a leg up from the pre-pandemic rate of 1.5%-2%.
Which is why we see expectations for long-term interest rates rising.
The long-run neutral rate (based on the Fed dot plot) has steadily increased in the past year, from 2.5% in Sept 2023, to 2.6% in March, and 2.9% in September of this year.
A higher neutral rate makes sense in a higher growth, higher inflation environment.
What does it mean for the interest rates near term?
Lots of data to get through before the next Fed meeting, but if November jobs come in hotter than expected I wouldn't be surprised with a pause on rate cuts at the December meeting.
