Commerzbank’s Volkmar Baur discusses how persistent high Oil and energy prices complicate the Federal Reserve’s stance, with markets only modestly pricing in further tightening. He highlights uncertainty over whether the PCE price index will remain the Fed’s inflation target as Kevin Warsh’s review of the inflation framework proceeds, warning that flexible definitions could ultimately erode credibility and weigh on the US Dollar.

Fed targets and Dollar credibility risk

"But of course, one thing is clear: the longer oil and energy prices remain high, the harder it will be for the Fed to resist raising the policy rate. While the Fed will point to the core rate, which excludes energy prices, persistently high energy prices make second-round effects increasingly likely."

"But even without rising energy prices: Just yesterday, our economists once again demonstrated that a return of the PCE (personal consumption expenditure) price index to a year-over-year change of less than 3% is anything but a foregone conclusion. It could very well be that we’ll have to wait until the end of the year before we see a “2” in front of the decimal point in the annual rate again. Perhaps even longer."

"All of this raises a question, however: How do we actually know for certain that the PCE price index will continue to be the Fed’s inflation target? After all, one of the Fed’s five task forces will be addressing the “Inflation framework” in the coming months. And Kevin Warsh, who has been very careful with his choice of words in recent weeks, has repeatedly emphasized in his speeches that the Fed will act decisively to restore price stability."

"Of course, not specifying which inflation rate is meant when referring to price stability increases flexibility. And this flexibility is important for responding as quickly as possible with monetary policy to falling or rising inflation. Over time, however, the market could also interpret this to mean that policymakers are simply cherry-picking the inflation rate that best suits their preferred monetary policy at any given time."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)