MacroResearchBoard

U.S. Inflation Is Back In Focus – January 13, 2025

The Fed has lacked a framework to guide its policy this decade and, thus, has been far offside in terms of understanding the inflation risks. Moreover, it has also misjudged the economy’s underlying strength. Consequently, it has been forced to pivot a number of times, with yet another pivot underway in the hawkish direction.

A just-published report updated our view on the U.S. inflation outlook and the consequences this will have for Fed policy (and the Treasury market). The conclusion was, not surprisingly, that the Fed made a mistake by easing last year, as policy never was restrictive and inflation is not tamed. Growth remains above the economy’s long-run potential and underlying inflation is starting to edge higher.

Net: if the Fed truly wants to bring down inflation to its target of 2%, then it will need to resume tightening policy to the point where the economy meaningfully weakens, aka a recession. Until then, the bear steepening of the yield curve will persist, as the deterioration in Fed credibility will continue to unnerve bond investors, causing bond yields to rise.