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Fed's Daly: Sept. SEP projections still good guide for policy after hot CPI

San Francisco Fed President Mary Daly joins Yahoo Finance Live to discuss various aspects of what the Fed's next steps may be.

Video Transcript

JENNIFER SCHONBERGER: Welcome back to Yahoo! Finance. I'm Jennifer Schonberger. Well, on the back of that hot CPI report that showed a core reading rising to the highest level in 40 years, investors are wondering what this means for the Fed and if they'll get more aggressive. Here to weigh in is Mary Daly, President of the San Francisco Federal Reserve Bank. President Daly, welcome back to the program. It's so wonderful to have you.

MARY DALY: It's wonderful to be here. I look forward to it.

JENNIFER SCHONBERGER: So I want to kick off this conversation and get your reaction to that CPI report and whether it changes the course of policy for you. If we look at the reading on inflation, it appears to be actually moving in the wrong direction, right? We saw core inflation, which excludes those volatile energy and food prices, rise 6.6% last month, up from 6.3% in August and 5.9% in July. Do you still see the Fed funds rate rising somewhere on the order of 125 basis points this year? Or does the Fed need to get more aggressive on the back of this report?

MARY DALY: Sure. And the CPI is one part of the dashboard of indicators we look for. It's an important one. And it does show the data not cooperating. It was a very disappointing report. But I would offer it wasn't that surprising. We would hope that inflation would start to come down faster. But I was prepared for it to just be sluggish in its response.

It's a lagging indicator. And so what I'm also looking at is what's going on in the inputs to inflation. Are demand and supply showing any signs of coming back in balance? And here I would offer two things, that you see the labor market cooling. It's still very strong. But it's cooling. You also see housing demand cooling. So the housing market is softening. And then today's retail sales report, which had showed flat spending is really another sign that we're getting some cooling. And that will eventually feed through to inflation.

So my own sense is that we went in. I went into this intermeeting period, if you will, thinking that we needed to continue to raise rates to further restrict the economy. And we'll have to be data-dependent about what actual rate hikes we take because we have domestic conditions. But we're also working in a global economy. And there's a lot of uncertainty and risks out there. And we have to think about those in the context of exactly what we do.

But there is literally no doubt in my mind that we need to put more restrictive stance of policy in the economy to further get demand and supply in balance so that consumers don't have to worry about such high inflation month after month.

JENNIFER SCHONBERGER: So given that you think this is a bit of a lagging indicator and you do see some signs of cooling elsewhere in the economy, does this keep the Fed basically on course for what's been set out for the next couple of meetings? Or what's your sense there?

MARY DALY: Well, let's go back to the summary of economic projections, lovingly called the SEP. And and that often it is stale right after it's produced. But in this case, I think that's a really good guidepost from our last meeting about what the path of policy is likely to look like. And then it's all about how do you get there? What's the path?

And the SEP, if you remember it, it came out at between 4.5% and 5% rates as the best estimate of what rates would be at the end of next year. And it also said that we could get up into the 4's, into restrictive territory, by the end of this year. And I still think that's a reasonable, really reasonable way to think about it. And I'm quite certain that some additional restriction is going to take place. And I do know that that's right for the economy.

We are tightening into a strong economy. And so we need to bring it back down to something that looks a lot more sustainable in terms of the pace of growth.

JENNIFER SCHONBERGER: OK, so then to be clear, 125 basis points higher on that Fed funds rate this year, and then looking at a peak of around 4.5% to 5% next year still seems to be the run of play in your mind. Is that correct?

MARY DALY: Well, what I would say, Jennifer, and I just want to be crystal clear. I know people would like us to write down the exact numbers for the rest of the period. But there's too much uncertainty for that to be prudent for us. We need to be data-dependent, extremely data-dependent. So clearly, the domestic data are pointing to further rate hikes. And I'm very supportive of continuing to put restrictions in place.

I see the SEP is a good starting point, a guidepost, for people to say that's generally where the Federal Reserve will be heading. That's consistent with my own views. But I also want everyone here listening to recognize that we're not on a pre-set course. We are a data-dependent Fed. And if more is necessary, we'll take it. If less is necessary, we'll adjust. But we're not talking about at this point in my mind pausing or stopping. Nor are we talking about changing our overall strategy because the data are coming in about like we would expect.

Monetary policy acts with a lag. Inflation is a lagging indicator. It is a hardship that it continues to print so high. And I am very focused on that hardship. And I'm very mindful, my contacts tell me all the time, that we want to make sure that price increases, that inflation doesn't become embedded in psychology. And that's why you'll hear me say again and again, we are resolute as an FOMC, as a Fed, restoring price stability.

JENNIFER SCHONBERGER: Given that you said monetary policy operates with a lag, you still think you would raise up till about 4.5%, 5%, and then pause at that point in 2023?

MARY DALY: Well, I think that's exactly the question we have in mind. And there's a big difference between what rate you get to and then holding it. Holding the economy in a restrictive stance of policy also continues to bridle it. So we'll end at a rate that we think is appropriate and in terms of where to stop and look around. But we still need to get the rates up before we ever do that.

And then we'll go to what I would think of as, what I call oftentimes a raise and hold strategy, where we raise it. And then we let that sit for a while. But we are always, even in that raise and hold piece, adjusting to the economic conditions as they come in. We are not on some sort of course that can't correct if the economy needs more bridling or needs less bridling. But really, that's how I think about it. Get to between 4.5 and 5 is the most likely outcome, and then raise to those levels, and then hold at that point for some period of time.

JENNIFER SCHONBERGER: You said there is a narrow path to engineer a soft landing for this economy. There is a window for that. And you think it is possible. That said, this week we heard that the IMF downgraded its global outlook. It says the worst is yet to come. And it warned about over-tightening from global central banks and the possibility of precipitating an unnecessarily harsh global recession. At the same time, we also heard from JP Morgan CEO, Jamie Dimon, who believes we could see a recession in the next nine months or sooner, given the impact of inflation on the consumer. They also said in their earnings report that they're setting aside $800 million for loan loss reserve. My question is where do you pin the odds of a recession in the next say 6 to 12 months?

MARY DALY: So you know, it's fascinating to me that we continue to be asked mostly by the media and others about recession. But when I'm out in my contacts-- I have nine Western states. I travel all over the United States-- I'm not hearing signs of recession. I'm hearing signs of we'd like to grow more. But we can't find workers. Or consumers saying, when is inflation going to go away? My life would be great if we didn't have such high inflation. People have plenty of jobs, opportunities. We still have a strong labor market. We have good consumer spending, even though it's flat. People are spending. People are doing things that they want.

But inflation is the troubling thing. I'll also point to one more data point that you didn't mention. Yesterday, I believe the Conference Board came out with their CEO survey. And those CEOs, 98%, expected some sort of a slowdown. What I remember from the report that was really meaningful and is consistent with what I hear when I talk to business contacts, workers, community groups is that people expect the slowdown to be there. But they expect it to be short lived and not very deep. And that's a very different landing.

That in my mind is the soft landing we're trying to achieve. We need to slow GDP growth substantially to get us back in demand-supply balance. The labor market needs to cool further. We're adding over 200,000 jobs per month in the last report. And that's another 100,000 over what it takes to just keep things steady then just absorb the new entrants that come into the labor market. So clearly, we're running fast demand and sluggish supply. Those things have to come back into balance. The Fed's tool, while it's blunt, it does directly affect the strength of demand. And we're committed to bringing demand back in line with supply.

JENNIFER SCHONBERGER: You mentioned that business executives expect if there is a recession it would be a milder one. How deep of a recession is the Fed willing to tolerate as you try to quell inflation and bring it down? And frankly, as a recession, what's needed to really get inflation under control?

MARY DALY: That's not how I think about my work actually. We have a dual mandate, full employment and price stability. My job, as I see it, is to treat those like they are. For most people, those things are related. They don't want only one or only the other. And so our job is to ensure that we can get a balance of both, get jobs. Everyone who wants a job can find one, even if it takes a little bit longer as the unemployment rate moves up, they're still going to find a job. And inflation comes back down to something closer to 2%, in the next year something closer, and then gets to 2% in the course of the next two years.

Those are critical things for us to achieve. And so I'm not thinking of it in terms of recession. I do think of it in terms of cooling the economy so the demand and supply come back into balance and Americans can go to bed at night and get up in the morning not worried about whether the prices they pay today are no longer going to be there tomorrow and they're not going to be able to afford the basic things they need to have their lives and livelihoods. That's what I think about.

JENNIFER SCHONBERGER: I do want to ask you about one other economic scenario. Since inflation has proven pretty sticky and the Fed does expect below trend growth this year and for the next couple of years as you're hiking rates to cool the demand side of the economy, what's the risk that a stagflationary environment could emerge? And how would the committee approach that?

MARY DALY: Well, so again, I think of stagflation, it's frankly a big, scary word. But look at the consumer sentiment that came out today. It rose. And then the future expectations slowed, of course, for growth. But that's consistent with what the economy needs. I think of what we're doing now as bringing inflation down so that we can have a durable expansion. And we know that durable expansions are the ones that are best for the labor market, best for all the groups that we care a lot about, and that high inflation is a tax, a regressive tax that's literally eating away at the lives and livelihoods of Americans least able to bear it.

So when I think of that, I think of slower pace of growth delivers lower inflation puts us back in balance, gets us in the best position to grow once again at trend. And I don't have any data right now that suggests that that's not possible.

JENNIFER SCHONBERGER: President Daly, I want to thank you so much for your insight. So appreciate it and hope to talk with you again soon.

MARY DALY: I look forward to it. Thank you so much.