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.
