China Merchants Macro says the Fed's reaction function has shifted and the near-term question of whether it hikes matters less for markets. Over the past two meetings both nominal and real US Treasury yields rose materially, suggesting markets have front-run Fed tightening. A Fed official outlined a three-part reaction function: 1) the Fed is downplaying its role as markets move ahead of policy; 2) with labor roughly balanced, the Fed will lean toward tightening if underlying inflation trends up

China Merchants Macro says the Fed's reaction function has shifted and the near-term question of whether it hikes matters less for markets. Over the past two meetings both nominal and real US Treasury yields rose materially, suggesting markets have front-run Fed tightening. A Fed official outlined a three-part reaction function: 1) the Fed is downplaying its role as markets move ahead of policy; 2) with labor roughly balanced, the Fed will lean toward tightening if underlying inflation trends up and will not readily "look through" supply-driven inflation, focusing instead on persistence and diffusion; 3) if price stability is achieved and underlying inflation falls, the Fed will be more inclined to ease. The official reiterated anti-inflation resolve but said he prefers a broader inflation gauge than PCE and hinted a new inflation metric could appear before next January. Until the Fed adopts a new inflation measure or demonstrates that high inflation is broadly persistent, the baseline remains for rates to be held unchanged.