US Inflation Expectations

The hawk goes dovish In Fedspeak, as in ice skating, usually you discard the views of the people at the extremes and listen to what the people in the middle are saying. Yesterday was an exception however, because the views of the hawkish St. Louis Fed President James Bullard proved so radical. A week ago (Oct. 10th), Bullard said that “the markets are making a mistake” and that rates would rise earlier than people think, probably at the end of Q1 2015. Yesterday he said the Fed should consider continuing with its bond-buying program, which is scheduled to end this month. “Inflation expectations are declining in the US,” he explained, adding, “we are willing to do things to defend our inflation target.” This is the first such suggestion we have had from any Fed official. Paradoxically, he also said he continues to see the first rate hike at the end of Q1, based on the expectation that the current global market turmoil won’t affect US prospects. Nonetheless, his suggestion opens up the possibility of delaying a rate hike if things don’t work out as hoped. Bullard is not currently a voting member of the FOMC.

 Despite Bullard’s comments, the implied interest rate on Fed fund futures actually rose 4 bps in the long end. This may have been because of the generally good US economic data: initial jobless claims were the lowest since April 2000, industrial production in September was better than expected, with manufacturing production reversing its August decline, and the Philadelphia Fed index was also better than expected. Only the NAHB index was down, although it remains in positive territory. So the picture in the US is of a generally strong economy and a central bank concerned about even the appearance of not hitting its targets.