MNI INTERVIEW: Fed Contacts Less Sanguine On Inflation–Tallman

Elevated U.S. inflation should begin moderating later this summer although concern from business leaders suggests it could take even longer to get consumer prices under control, Cleveland Fed research director Ellis Tallman told MNI.

“It’s incredibly volatile. When I talk to people who are actually doing the business, you get a less sanguine view of when that turnaround is going to be,” Tallman said in an interview.

“From a forecasting side it would seem like it could be this summer, but from conversations it appears that very few in our markets, in our district are saying they see the inflation rate diminishing notably in the short-term.”

Tallman declined to give a specific point forecast but said his views are generally in line with the Fed’s Summary of Economic Projections, which sees PCE inflation ending 2022 at 4.3% after surging to 6.4% in the year to February.

SUPPLY SLOPPINESS

He said the timeline for supply chain disruptions keeps getting pushed back, dealing another blow to forecasters’ ability to see an end to the surge in the rate of price increases that caught policymakers largely by surprise.

“We just had an additional shock with the ramifications of Russia invading Ukraine, so it puts the standard expectation of when things are going to peak a little further out,” he said.

“It seems like we’re going to trudge through this, but there are going to be price responses whether demand moderates or not. The question is how much is going to be passed through and how fast – clearly it will be worse if demand continues to be that far in excess of supply.”

He indicated that as the Fed tightens monetary policy this year, policymakers would need to see consistent declines in the inflation rate before taking any real comfort, given the danger that any moderation in the rate of price rises might prove fleeting.

“By the end of the year I do see us coming down somewhat towards a more reasonable (rate), it’s still going to be above the 2% target but it’s not going to seem like the inflation rate is not responding."

Still, Tallman takes comfort in longer-run inflation expectations which are still well contained despite a spike in shorter-term expectations.

“I see near-term inflation expectations being higher but I don’t see any evidence that compels me to think that inflation expectations have become dislodged,” he said, citing the Fed’s hawkish policy pivot as an explicit effort to ensure expectations are anchored.

“We know what happens when inflation gets embedded and when monetary policy has to create a circumstance like 1979 to 1980 – we know what happens there, so that’s what we’re trying to avoid.”

RECESSION RISK

Tallman said recession risks are increasing as economic activity slows, but added that he does not see them as substantial enough to dissuade Fed officials from pursuing the monetary tightening they began in March.

“I think the probability of a recession has increased – I don't think it’s imminent, it’s not something that should stop monetary policy from reducing accommodation,” he said.

The economy is enjoying a great deal of momentum as a historically low 3.6% jobless rate and blockbuster monthly job growth suggest.

“The labor market is extremely tight and that’s why wages are increasing,” Tallman said.

Asked about a flat or inverted yield curve, Tallman said it was not an infallible signal though it should not be downplayed. He said special factors like the drag on long-run rates from years of QE could be muddling the yield curve’s message some.

“In this case there are some extenuating circumstances that may make it challenging” to read, he said. Still, “It’s certainly worth watching and not dismissing.”