Fighting inflation is job number one for the Fed right now. Jerome Powell made that crystal clear in his remarks from Jackson Hole on Friday. He discussed the deleterious effects of inflation and the risks that come with prematurely claiming victory (and loosening policy). This could lead to more persistence in raising rates, more tolerance of economic weakness, and more willingness to keep rates high for an extended period of time. In this environment, inflation data will be scrutinized more than ever. While inflation expectations get a lot of focus, they are much more closely related to where inflation has been than where it is going. There is an 85% correlation between 5-year CPI inflation and current 5-year inflation expectations. That drops to just 26% when inflation expectations are moved ahead 5 years (so that the inflation data and expectations data are covering the same time period). If inflation stays high, expectations will become further unanchored. Alternative measures of inflation (like the median CPI from the Cleveland Fed and the trimmed-mean PCE from the Dallas Fed) show that the central tendency for inflation remains higher. The Fed is likely in for a long fight - the question from our perspective is whether this macro issues will overwhelm the positive market developments that we have been observing in recent weeks.
