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Jim Bullard, the president of the St. Louis Federal Reserve Bank, has been warning for months that the central bank risks losing credibility if it does not hurry to tighten monetary policy. He was the only member of the Fed’s latest policy projections plot to post a fed funds rate above 3% by year-end, and investors widely called him the “biggest hawk” in the world. committee. He was right, and now the Bullard case is becoming the market benchmark.

Bullard was vindicated, of course, after inflation hit a new four-decade high in May and survey data showed consumers’ long-term inflation expectations are on the rise, a telltale sign. that high inflation is likely to take root. Now the Fed will have to reach Bullard levels anyway, but without the benefit of a quick start. He was right to pressure his colleagues to start raising rates by 0.50 percentage points in March and again when he said the Federal Open Market Committee should maintain increases of 0.75 percentage point on the table.

Much has gone wrong over the past few months, and much can still be attributed to supply chain dynamics and how Russia’s war in Ukraine is putting pressure on global food and energy. Bullard couldn’t have known that West Texas Intermediate oil would take another run at $120 a barrel or how China’s latest Covid lockdowns would unfold, but he understood the balance of risk better than his colleagues and knew it wouldn’t. was not the time to take a nonchalant approach to rising prices. Today, inflation is affecting every corner of the US economy, and consumers may be losing faith that the Fed really means it when its officials talk about bringing inflation back to its 2% target. It’s worth listening to it a little closer from now on.

Consider a presentation Bullard gave at Princeton University’s Bendheim Center for Finance in April. At the time, he walked through the construction of a Taylor-rule-type policy rate calculation using what he called “generous assumptions” about inflation to set a “minimally reasonable” level for the rate. director. His simple calculation revealed(2) that the fed funds rate should hit around 3.5%, a call that fixed income markets are finally approaching two months later and only after the week’s discordant inflation numbers. last.

Unfortunately, today, even the most “generous” inflation assumptions are even higher. Bullard’s measure of core inflation – the Dallas Fed trimmed average – rose to 3.8% in April and is expected to rise further in May, extrapolating from the price index at consumption released last week. The corresponding Bullard model would spit out a policy recommendation of around 4% now.(1) Sure, Bullard thinks monetary policy works in part because of forward-looking and market pricing, and bond and swap markets are adjusting already to this new reality.

So where will the markets and the Fed go from here? Bond yields continue to rise and the Nasdaq Composite Index saw its biggest two-day drop since the start of the Covid-19 pandemic, as financial markets accept that inflation will not disappear as easily as many had hoped so.

It’s impossible to say what’s next, of course, and a lot could happen that could still force the Fed to change course. Circumstances may well change again in the coming months: energy prices may ease and supply chains may unravel. But whatever happens, it’s worth watching more closely for signals from the economist most on Wall Street used to denigrate as “the hawk.” Turns out he’s just “the realist.”

(1) Bullard’s simple Taylor-type formula, based on the rules-based approach proposed by Stanford economist John Taylor, uses the following equation with “generous” assumptions: -0.5 + 2 + 1.25 (3.6 – 2) = 3.5%, where -0.5% is the R-star real interest rate, 2% is the inflation target, 1.25 is a value of parameter for policymakers’ reactions to deviations, and 3.6% was the value at the time for the Dallas Fed’s average-adjusted PCE.

(2) Assuming the average Dallas Fed PCE will reach around 4% in May.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.

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