MNI INTERVIEW: Fed Needs More Hawkish Message - Emmons
A stagflationary outlook with rising inflation expectations means the Federal Reserve needs to send a more hawkish message that it stands ready to fight prices even it means angering President Donald Trump and risks for growth and employment, former St. Louis Fed economist William Emmons told MNI.
The Trump administration's "policies so far seem to be -- and market reactions to them are pushing us -- in the direction of less growth and more inflation," he said in an interview. "It's stagflationary."
Inflation has been above the central bank's target for four years and the most recent Fed projections showed officials already expected it to be above the 2% target for another three years, even before Trump's larger-than-expected tariff announcements, he noted. "The Fed should be calling Trump's bluff. They should be saying, if your tariff policies are inflationary, we will fight them, even if that means harming the economy."
"All of the evidence of how people form expectations is suggesting that there is an existing problem, and it's getting worse right now with the tariffs in particular," said Emmons, who spent nearly three decades at the St. Louis Fed. "The signal is sounding loud and clear. Anybody who says that you're not getting a signal now about inflation is just ignoring the evidence." (See MNI INTERVIEW: Inflation Expectations Surge, Troubling For Fed)
EARLY PREDICTOR
Fed officials should focus on consumer surveys showing short-term price expectations rising once again, just a few years after the pandemic surge that saw inflation hit 40-year highs, Emmons said. Market gauges of inflation expectations are more sanguine but are unreliable amid market gyrations, he added.
"It's almost a mantra now to talk about long-term inflation expectations and how they don't see a problem there,” he said, referring to recent Fed rhetoric. "Fed policy makers are making a huge mistake to dismiss the short-term inflation expectations, and they are sort of making a hostage to fortune in saying long-term inflation expectations are fine."
Short-term expectations are an important predictor of actual inflation and are also essential to the formation of long-term expectations over time, he said. "The whole point of watching inflation expectations is to give you early warning. You're getting early warning right now in the most robust part of that information space."
Preliminary results of the University of Michigan consumer survey showed year-ahead expectations surging to 6.7%, while anticipated inflation five-to-10 years ahead rose to 4.4%. The New York Fed survey showed a half-percentage point rise in inflation expectations for various items over the next year, but longer-term expectations were unmoved. (See: MNI INTERVIEW: Inflation Uncertainty Deters Fed Easing -Evans)
The Treasury market is sending unreliable signals about the path of prices, Emmons said. Markets are being disrupted, with flight to quality effects, liquidity effects, portfolio rebalancing effects, and foreign exchange pressures.
"For all those reasons, it seems to me now is exactly the kind of time when you would want to downweigh the importance of these market-based measures," he said. "Break-evens that are coming out of the long end of the Treasury market are probably distorted right now."
SEND THE SIGNAL
Markets are betting that the Fed and Chair Jay Powell will not stand up to President Trump and will lower interest rates three times over the course of the year, Emmons said. Investors think Powell "doesn't really believe in the 2% target and he will cave if the economy looks weak," like in 2019, he added.
"If it is potentially a persistent inflation effect of tariffs, any self-respecting inflation-targeting central bank will say, we are going to fight this. Maybe the Fed doesn't raise rates immediately but they need to send the signal," Emmons said.
