MNI INTERVIEW: US Inflation Has Likely Peaked-Fed’s Andolfatto

U.S. inflation has likely peaked and markets may have overpriced how much monetary tightening the Federal Reserve might deliver over this cycle, St. Louis Fed economist David Andolfatto told MNI.

Andolfatto said the waning effects of the large fiscal response that followed the Covid shock as well as easing supply chain constraints will mean inflation, while remaining high, will gradually start coming down

“I think we have hit peak inflation,” said Andolfatto, a senior vice president at the St. Louis Fed, in an interview. “The signs I’m looking at, international shipping rates are coming down pretty aggressively, if you take a look at commodity prices they seem to be coming down pretty aggressively.”

“I’d say inflation is going to remain elevated for the rest of the year but it’s going to be coming down. And the reason I say that is what are the forces that are going to keep elevated at eternally high rates of 8%? I just don’t see it.”

Fed officials have said a surprisingly strong 8.6% jump in May CPI helped convince the FOMC it should raise rates by a more aggressive 75 basis points, the biggest hike since 1994, rather than the 50-basis-point increase that had been previously communicated to markets.

Asked if financial markets had priced in sufficient Fed tightening, Andolfatto said: “Maybe the market has overpriced it.” Fed funds futures markets are currently pricing in a terminal Fed rate of around 3.6%, in the range that Fed officials offered in the June SEP, though in the near term 75-basis point-hikes have become the new baseline. (See: Fed Sees 75BP Hikes As New Baseline-Ex-Officials)

“I think the sentiment is probably true that the Fed will at the end of the day do whatever it takes to get inflation down," he said. "But fiscal policy has to to be playing its role and it is. I’m hopeful that the fiscal drag and the monetary tightening that we’re seeing is going to manifest mainly in nominal variables not so much in real variables.”

NO RECESSION IN SIGHT

Andolfatto still sees a soft landing as a decent possibility.

“We’re going to get if anything a very mild contraction from the tightening per se. That’s my hope. I think as long as we don’t freak out and that inflation is coming down, that the adjustments are not going to be too severe, and we’re going to be fine,” he said.

"But what’s the shock that’s going to send us to recession? I don’t see any shock out there, apart possibly, and I hope this doesn’t happen but if the Fed goes crazy and jacks up interest rates like in the Volcker era."

He indicated though that such an outcome is quite unlikely.

While his view of peak inflation is relatively optimistic, Andolfatto cautioned that additional geopolitical surprises could always alter the outlook.

NO FURTHER SHOCKS

“There could be other shocks of course, what if this conflict in Europe expands? I think we’ve hit peak inflation, conditional on no further shocks,” he said. “So far I think what we see is the supply side is showing signs of repairing itself and the fiscal stimulus is going to dissipate over time. Notwithstanding other supply shocks, war, or further fiscal shocks, I think inflation is coming down.”

Andolfatto was one of the first sitting Fed staffers to cite the risk of high inflation, telling MNI in February of 2021 that the risks were rising of a significant inflation spike. And yet he still believes the economy has not entered a new, high inflation regime.

“I was early in calling for some inflation although I couldn’t have made a statement about how severe or how long it would last. We did get inflation, it was higher and more persistent than I expected."

At the same, time, he added: “I’ve been on team transitory for a while. I’m still on team transitory.”