In November, the U.S. Federal Reserve cut interest rates for the third time this year, seemingly completing this round of “insurance” cuts. While economic growth in the U.S. remains positive, inflation continues to undershoot, creating a conundrum for the Fed, given its dual mandate of full employment (check!) and well-anchored inflation around 2%. Currently, 5- and 10-year inflation breakeven rates sit at 1.55% and 1.67%, respectively – well below target. It is important to note that this is a global phenomenon; inflation has undershot central bank targets persistently, with the 2% target seemingly unattainable on a consistent basis.
Recently, the Fed has begun internal discussions about modifying their mandate to allow for a more credible, symmetric inflation target. Under this change, the Fed would allow periods of persistent undershooting, such as the current period, followed by periods of overshooting, without the typical central bank response. This is aimed squarely at re-setting inflation expectations higher. Nonetheless, we continue to believe that a sustainable reset remains challenged by structural inflation headwinds: most notably, high levels of global debt, demographics and increased use of technology.