On Thursday, Philadelphia Federal Reserve President Anna Paulson stated that she and her colleagues might need to increase interest rates again in order to return inflation to its target level.
A week on from the Federal Open Market Committee raising benchmark borrowing rates by a quarter percentage point, Paulson has said that inflation trends remain troubling. The rate hike brought the target funds range up to 3.75%-4% “brings policy closer to what I believe is needed to return inflation to 2% at a pace that balances inflation with risks to the labor market.”.
“Looking ahead, if conditions evolve as I expect, some modest further tightening may be warranted.”
She said the summer brought some easing in price pressures, but underlying inflation remains around 2.5%-3%. In prepared remarks for a fintech conference in her home district, “well above our 2% target, and the gap has shown little signs of closing.” “The best I can say about underlying inflation this year is that it hasn’t gotten worse,” Paulson pointed to that figure. She also noted that inflation has stayed higher even beyond the oil supply shocks tied to the Iran war and tariffs.
What Paulson Said
One week on from the FOMC raising its rate by a quarter percentage point, Paulson has spoken. That increase put the key funds rate at a target range of 3%-3.75%.
The shift was framed by Paulson as a step toward aligning policy with what she judges necessary to bring inflation back down to 2%. She also noted that the pace of action should be calibrated so that it balances the goal of controlling inflation against any danger to the labor market.
The speaker pointed out that underlying inflation has stayed high. She estimated that core inflation is still moving in a range of roughly 2.5% to 3%, “well above our 2% target, and the gap has shown little signs of closing.”.
Outside of inflation, Paulson said economic output “has been solid” while the labor market is “holding steady.”
Markets Are Pricing In More Hikes
Markets have dramatically raised their expectations for tighter Federal Reserve policy, and that has pushed longer-duration Treasury yields to levels not seen since 2004, with another leg up this week.
The CME Group’s FedWatch tool shows traders are currently pricing in a 64% probability that the FOMC raises rates again in October, followed by another expected move in January. Fed funds futures contracts imply a rate of 4.8% by the end of 2027, which points to an expectation of as many as four quarter-point increases remaining on the table.
New York Fed’s Williams Agrees
New York Fed President John Williams said earlier Thursday that he thinks it’s “reasonable” to expect another hike before the end of the year.
The Case for Further Tightening
Two claims support Paulson’s argument: first, underlying inflation remains above its target; second, the difference between actual inflation and the target has failed to narrow.
Outside of the oil supply shocks from the Iran war and tariffs, Paulson said inflation has held higher, which he took as evidence that the pressure is not confined to those specific events.
What Comes Next
The way ahead is not fully defined. If things develop as she expects, Paulson said a small additional tightening of policy may be needed.
The market is assigning a 64% probability to a further increase at the October FOMC meeting, with a second move anticipated for January.
The market’s general expectation lines up with what Paulson says, but his description concerns a choice rather than a forecast.
- Paulson says modest further tightening may be warranted.
- Traders price in a 64% chance of an October hike.
- Futures imply a rate of 4.8% by the end of 2027.
- Williams says it’s reasonable to expect another hike before the end of the year.
According to Paulson, she appears willing to back a further increase should the numbers match what she has described as her requirements.
The economy is growing at a strong pace and the jobs market remains steady. Paulson’s caution about inflation points to a preference for tighter policy over looser.
Her remarks follow a certain pattern: she keeps a close watch on inflation, and she has made clear she is prepared to take action if it fails to come down.
An October increase and a further move in January are already built into the market’s pricing. According to Paulson’s remarks, that course of action remains under consideration.
Source material: “Philadelphia Fed's Anna Paulson says 'modest' rate moves likely ahead to tame inflation,” CNBC.
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