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Investors are overplaying fears about faster inflation when the real risks are another long period of sluggish price gains and tightening policy before testing how far the job market can run, San Francisco Federal Reserve President Mary Daly said Tuesday.
"A swell of market and academic commentary has started to emerge about a quick snapback, an undesirable pickup in inflation, and the need for the Federal Reserve to withdraw accommodation more quickly than expected. I see this as the tug of fear," Daly said in the text of a speech to the Economic Club of New York.
Even historically low unemployment can be consistent with inflation stuck below target, a lesson Daly suggested should be applied following the pandemic. The Fed faces "an uphill battle" to meet its goals of averaging inflation at 2% and restoring full employment, meaning "our most important virtue will be patience," she said.
"As for the likelihood of runaway inflation, I don't see this risk as imminent, and neither do market participants," said Daly, who joined the FOMC as a voting member this year. "Instead, I view the recent rise in inflation compensation to roughly 2 percent as encouraging and in line with our stated goals. It suggests that our commitment to flexible average inflation targeting has already gained substantial credibility."
While some bond yields have surged in recent weeks, they don't yet signal that inflation is heading to the Fed's target soon. Two-year Treasury bonds traded for 0.23% on Tuesday and since the middle of last year have tracked the Fed's 0-0.25% target range for its overnight policy rate, while 10-year debt yielded 1.42% after recently hitting the highest in a year.
"It will likely be some time before inflation is sustainably back to 2%," Daly said. Policy must guard against expectations of low inflation becoming more entrenched because "long periods of below-target inflation, like the one we are experiencing, are costly," she said.
"Getting fully past this crisis and back on track to achieve our dual mandate goals will require monetary policy to be accommodative for some time."