The Fed Post-Election: Inflation Still the Focus

The U.S. midterm elections appear to have given strong support for the Federal Reserve to continue its aggressive campaign to lower U.S. inflation. Exit polls showed that inflation was the top issue among voters. Critics who argue against the Fed’s inflation-fighting rate hikes may encounter a less sympathetic audience among Fed policymakers.

Although today’s release of the October U.S. consumer price index showed an unexpected decline in inflation, Chair Jay Powell has repeatedly emphasized that the Fed does not put too much weight on a single month’s data. His comments following last week’s Federal Open Market Committee meeting likely still reflect current Fed thinking — that a strong labor market continues to support stubbornly high inflation and that the risk of doing too little still outweighs the risk of doing too much.

Most bond investors seem to believe that the Fed will be successful in driving inflation much lower from the 7.7% experienced over the past year. Next year’s Treasury-market-implied inflation rate is approximately 3%. In the following years, the implied inflation rate falls further and approaches the Fed’s long-standing 2% target.

Future challenges for the Fed include the possibility of a significant slowdown in the economy coinciding with an inflation rate that remains stubbornly high. In this case, the voices of Fed critics advocating more dovish policies could grow louder. Investors may speculate on how the Fed would react, but the Fed has not yet provided detailed guidance on how it would respond.