US Economics Weekly: Reassessing risks to our Fed call after the latest data

Research evidence excerpt

US Economics Weekly: Reassessing risks to our Fed call after the latest data

IdeaM

Reassessing risks to our Fed call after the latest data

When we wrote our outlook, we highlighted two scenarios under which inflation

would run higher and the Fed would either remain on hold for longer or potentially

hike rates: a demand push scenario, and one featuring a persistent oil premium stemming

from a prolonged US-Iran conflict.

In the demand push scenario, stronger consumption and business investment—supported

by elevated wealth and improving confidence—drive a reacceleration in growth and

tighter labor market conditions. As a result, inflation pressures remain firm even as oil

dynamics normalize, with tighter labor markets reinforcing persistence in core inflation

and ultimately prompting the Fed to begin hiking once it becomes clear that the strength

reflects demand rather than productivity. By contrast, in the permanent oil premium

scenario, oil prices remain structurally elevated, leading to sustained supply side pressures

and gradual pass through into core prices. While growth is somewhat softer, inflation

remains persistently above target, keeping the Fed cautious and on hold with a high bar

for easing.

The recent developments in the Middle East, together with last week’s employment

report and this week’s inflation data, suggest that both scenarios may be becoming

more likely than we initially anticipated.

On net, the data indicate that the balance of risks is shifting in the direction of firmer

inflation over weak hiring. This is different from a year ago when the Fed said downside

risk to labor markets outweighed inflation concerns and cut its policy rate by 75bp,

The employment report pointed to a labor market that continues to firm. Payroll