San Francisco Fed President Mary Daly Explains the 'Hawkish Cut'

SPEAKER_1 (0:03)

Bloomberg Audio Studios, podcasts, radio, news.

Tracy Alloway (0:20)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:24)

And I'm Joe Weisenthal.

Tracy Alloway (0:26)

Joe, how about that hawkish cut, eh?

Mary Daly (0:27)

Ha, ha, ha, ha, ha.

Joe Weisenthal (0:29)

Exciting, interesting times in macroeconomics, the Fed, the markets, plenty to talk about right now. We're recording this December 20th.

Tracy Alloway (0:39)

Yeah, we're recording this December 20th. So two days after we had what is being called a hawkish cut from the FOMC, the central bank decided to cut by 25 basis points, but at the same time, they unveiled their new forecast for next year, and it looks like the expectation is that inflation maybe is gonna be a little bit more stubborn, and maybe we're only gonna get two cuts next year. And markets promptly fell out of bed. They did not like that revised forecast, to say the least.

Joe Weisenthal (1:08)

Yeah, and it's a little surprising, and we'll get into it. I think to some extent, a lot of it was expected, but there are real tensions right now, right? So we have had a stubborn sideways inflation prints in recent months, maybe not quite the soft trajectory back down to target. The fact that we might not be down to target completely in 2025 Some questions about labor market stability, plenty to dive into, plenty of crosswinds for investors, traders and so forth to digest.

Tracy Alloway (1:38)

Crosswinds is a nice way of putting it. I feel like anyone who was hoping for a quiet end to the year might be disappointed with everything going on. But Joe, I have to say we really do have the perfect guest to dive into all of this. We're going to be speaking with Federal Reserve Bank of San Francisco President Mary Daly herself, a voting member on the FOMC. So Mary, thank you so much for coming on Odd Lots.

Mary Daly (2:01)

I'm delighted. My lucky day.

Tracy Alloway (2:04)

So why don't I start with the obvious question and one I think I suspect you've been asked this multiple times over the past couple of days, but why cut at all if you think that inflation is expected to show not that much progress into next year and maybe not reach 2% until 2027?

Mary Daly (2:24)

It's a great question. And if I can take a minute, I'll explain exactly how I thought of it. So we had policy, rightly so, at a highly restrictive level. Remember the interest rate was really high, historically high, and that was to fight very high inflation and a very robust labor market was helping spur high inflation, the economy was out of balance. So now that we have inflation that is much lower, we've made tremendous progress towards getting it back to 2 We're not there yet. And the labor market is balanced, now completely balanced. It's appropriate to move into a more moderate level of restrictiveness. Otherwise, what you end up doing is breaking the economy. If you leave the higher level of restrictiveness on while you're closer to your goals, the economy just starts to falter and you end up getting inflation down, but at the expense of people's jobs. And that's not a recipe for a soft landing. That's a recipe for a very hard landing. And it takes away what people have really wanted their entire time that we've been in this high inflation period, which is low and stable inflation and jobs that help them grow their careers and communities and families. So that's why we cut the rate in my judgment. That's why I supported it. It was a close call, whether it's 75 or 100 basis points in total, that's the right level to get from highly to moderate. For me, we now have completed that recalibration, right sizing. And now we can look at the data and the incoming information and our projection of how the economy will evolve and take our time to make any additional policy adjustments.

Joe Weisenthal (3:59)

So, if the labor market is, as you put it, in balance and no longer a driver of inflation, and yet inflation has been sideways above target, in fact, the inflation forecast per the dots for 2025 ticked up, what is the residual source of the inflation if it's no longer the labor market?

Mary Daly (4:19)

Yeah, that's another great question and one that we think a lot about, I think a lot about it and really it traces to two things right now.

One is driving it up, maybe temporarily, it's hard to say, and the other one is a more persistent issue. So let me start with the first one. It's non-market prices. And what that means for people who are really into this like me is that it's prices we don't actually measure, we estimate. And we're not doing this, the BA and BLS are doing all the data collection, but it's really these prices that we don't know, we can't see them exactly, and so we estimate them. And so financial services prices, for instance, are based on asset values, and those have been up. So it feels like inflation is high in those areas, partly because of the estimates, but it's hard to get your mind on that as a fundamental underlying inflation. It's not really what people think about when they think of, you know, high inflation is hurting me. They're thinking about other things. So that's one factor. The second factor that's really been elevating inflation is housing services, the price of housing and the price of rentals. Now what's interesting there is rental prices have been coming down, but home prices haven't been falling as much. We're not seeing that gap close. And unfortunately, we have a structural issue there that has nothing to do with our Fed policy. It's really about the substantial, significant, very, very large shortfall in housing relative to the number of people who want it. And so that's something that, you know, maybe stickier for a longer period of time than we thought, and will cause inflation to be elevated.