Mining wage

The Fed’s main objective is to prevent the spiral of wage inflation and a higher inflation regime: economist

Greg Daco, chief economist at EY-Parthenon, joins Yahoo Finance Live to explain where the Fed is in terms of tackling record inflation in the country.

Video transcript

SEANA SMITH: We have rising food prices, rising gasoline prices, pushing inflation to the highest levels we’ve seen since 1981. That’s fueling bets that the Fed will get even more aggressive in tackling inflation . We want to bring in Greg Daco. He’s the chief economist of EY Parthenon. So, Greg, the big question is, we have this very, very hot feeling of inflation. What should the Fed do next? How do you see or how do you think the Fed should solve this problem, purely in terms of policy? How much more aggressive should they potentially be?

GREG DACO: Well, I think what we’re seeing right now in terms of inflation dynamics is that it’s quite broad inflation dynamics. It is not just a sector that is experiencing higher prices. As Brooke said, grocery store prices are going up. We see energy prices rising. We see the prices of goods rising, the prices of services rising, the prices of housing rising. Everything increases in terms of inflation. And that’s certainly not the kind of backdrop the Fed appreciates. The Fed would like to see a much lower level of inflation. Regaining control of inflation will be its main priority.

And to do that, he will have to insist more on the political pause. I expect next week the Fed will continue to hike rates by 50 basis points. But there is growing talk that there could be a 75 basis point hike at one of the next meetings, or that the Fed could make longer 50 basis point hikes. basis after the July meeting, which we know will likely be a 50 basis point rate hike. also meet.

DAVE BRIGGS: Greg, if there’s ever a moment to contradict conventional wisdom, forget about the fact that you took 75 off the table. Isn’t this number irrefutable proof that we need a 75 point hike? Why not go against conventional wisdom and do it next week?

GREG DACO: Well, I think we’re real close to the meeting right now. And the Fed prepared the markets for a 50 basis point rate hike. There will certainly be a lot of talk at the FOMC meeting, where some participants will most likely support a 75 basis point rate hike at next week’s meeting.

I expect the Fed to stick to 50 basis points, but what I also expect to see is Fed Chairman Powell talking about optionality, optionality to either extend further rate hikes by 50 basis points or proceed with further rate hikes if there is not t the so-called considerable and clear evidence that inflation is moving in the right direction.

RACHELLE AKUFFO: And obviously with this data that we’ve seen coming out, people, of course, are bringing the talk back to recession versus stagflation. Talk about the risks that each of these risks carry and the likelihood that we will see them happen.

GREG DACO: I think you have to keep in mind that today the US economy remains relatively robust. We still have a job market that offers a pretty solid amount of jobs on a monthly basis. We still have an environment in which job growth remains quite strong. But there are signs that inflation is beginning to erode. Morale is starting to weigh on the evolution of consumer spending.

And that will be a major concern for the Fed, as the Fed needs to rebalance its stance on inflation, as well as prevent a slowdown in economic activity. I don’t think stagflation is really a risk for 2022. But I do think increasingly, with inflation lingering and the economy likely to slow faster, stagflation could very well be a story for 2023.

SEANA SMITH: Greg, with respect to Fed Chairman Jay Powell’s comments on inflation, I guess how much confidence the market has in what he’s saying, given the track record we’ve seen in over the last few months? And has he completely lost the narrative of inflation? Does the market just not trust him at this point?

GREG DACO: I think it’s more a question of whether the next rate hikes will be enough to calm inflation. We have a serious and lasting gap between demand that remains quite robust and supply that is struggling to keep up with this demand. We will see that these two elements will rebalance each other. But on top of that, we need more Fed tightening to calm some of the demand. Slowing demand and tighter financial conditions will be a hallmark of effective monetary policy. It won’t be a bug.

The Fed is therefore not going to back down at the first signs of a market correction or at the first signs of a slowdown in demand. This is what the Fed wants to do. He wants to prevent the risk of a spiral of wage inflation or the entry of the American economy into a regime of higher inflation. This will be the main objective of Powell and the rest of the Fed, but it will be a very delicate exercise. And I think the more persistent inflation appears, the more likely the Fed is to hit the brakes harder and the more likely we are headed for a deeper slowdown.

RACHELLE AKUFFO: And I mean consumer sentiment falling to that all-time high of 50.2% from May’s reading of 58.4%. The University of Michigan Consumer Sentiment Survey indicates that this level is comparable to the low point reached in the middle of the 1980 recession. But how concerning is this, given that consumer spending is not aren’t as bleak as what we’re seeing with consumer sentiment?

GREG DACO: Well, I think we need to understand what the different sentiment measures show. The University of Michigan’s measure of consumer sentiment is heavily biased toward inflation. It is a measure that gives a lot of importance to inflation, to gas prices. And we’ve seen that gasoline prices have really gone up. It is therefore a major concern for American consumers.

At the same time, we are also seeing a robust labor market. So other confidence measures actually point to a better environment for overall spending. And we continue to see people spending. Consumers continue to spend. Retail sales were still on the rise in May. So it’s quite encouraging overall. And I think what the Fed wants to see is actually a cooling in consumer spending momentum. It is unlikely that this will happen before the end of the summer. We’re still expecting a fairly strong travel season, as we’ve talked about. We continue to see strong bookings of hotels, airline tickets. And that should continue to put upward pressure on service-sector inflation.

DAVE BRIGGS: Long way to go. Greg Daco, I really appreciate your presence here. Enjoy the weekend, sir. Thank you for your analysis.