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00:00Joining us now to extend the conversation on the Federal Reserve, the San Francisco Fed President, Mary Daly, joined us
00:05for more.
00:06President Daly, always good to hear from you, so thanks for making some time for Bloomberg Surveillance.
00:09Glad to be here.
00:10I want to bring up the bond market, and I'm sure you anticipated I would go there first.
00:14The long bond and the rise we're seeing in yields.
00:17President Daly, from your standpoint, what signal, if any, do you take from the sell-off at the long end?
00:22Well, you know, when you look at the long end, it is typically driven by structural factors like fiscal sustainability,
00:28geopolitical rebalancing,
00:30the massive AI investment for this industrial renaissance, which people are very excited about, and those factors are driving this.
00:39The thing that I look at specifically is this is happening across the globe.
00:42It's not just a U.S. phenomenon.
00:44It's a global phenomenon.
00:45And it doesn't give us a lot of signal about what we should do in the policy adjustments or the
00:50policy calibration for the Fed.
00:52And there, if we look at the short end more than the longer end, paying attention to the longer end,
00:57but really focusing on the job number one, which is restoring price stability right now.
01:02Do you think, President Daly, that the long end of the yield curve is doing some of the work for
01:06the Federal Reserve
01:07by tightening monetary conditions in a more significant way?
01:11You know, I always hesitate to say that the market's doing our work.
01:14But what I will say is it begs the question, what problem are we trying to solve by adjusting policy
01:21preemptively?
01:22You know, there's a lot of discussion about our credibility there.
01:25I don't see our credibility at risk.
01:28I also hear a lot about should we be making preemptive cuts or hikes, rather.
01:32And I don't see a lot of evidence that that's an urgent problem to solve.
01:36So, really, this is about watching the inputs from the financial markets, looking at the 30, the 10, and the
01:422,
01:43and asking, are we getting mixed signals or different signals?
01:46And, you know, right now, on the shorter end of the yield curve, markets seem to have priced in a
01:51little bit more tightening.
01:52But they're reacting to the data just like we would expect them to.
01:55Inflation prints a little softer than they expect.
01:58The labor market a little softer than they expect.
02:00They push out rate hikes that they had priced in and adjust as the data comes.
02:05So, I think they seem to be signaling to us that they understand our reaction function.
02:09And, importantly, I'm looking at inflation compensation and inflation expectations.
02:14And you don't see any, you know, worrisome swings in those pieces of data either.
02:20So, I think policy is in a good place.
02:21But watching this 10 and 30 to see what we need to think about, what are the structural factors, it's
02:28giving us a signal about something.
02:30And I think one of the big signals is the AI demand.
02:33President Taylor, we'll get into AI demand, but I am curious about the reaction function.
02:38You said that the market seems to be understanding the Fed's reaction function.
02:42What is your reaction function in terms of incoming information that would make you think that an adjustment higher for
02:49rates would be required?
02:51Well, you know, last week I gave a speech where I talked about, really, there's, you know, there's many scenarios
02:57that could occur.
02:58But two seem very important for me at this point.
03:01One is the one that I would suggest is the modal outlook.
03:04My modal outlook is that, you know, and also you saw in the minutes, it's a majority of the participants'
03:09modal outlook.
03:10That inflation is being driven up by a series of shocks, and those shocks will roll up, they'll roll down,
03:17they'll roll through.
03:18And as that dissipates, then inflation will return to target, in part because we have policy at a very slightly
03:25restrictive level.
03:26So, there's that dynamic.
03:28But then there's the dynamic of maybe the fact that we have so many shocks coming at once and they're
03:33overlapping, they can have an independent compounding effect that means that the total effect is greater than the sum of
03:40its parts.
03:41The conventional dynamics of shocks just aren't working like they were.
03:44I'm not seeing evidence of that right now, but I definitely think we should keep that in mind and watching.
03:50If that happens, we would have an inflation problem that we would want to treat with tighter policy.
03:56In the meantime, I was very supportive of the July hold and continue to look at the information that comes
04:02between now and the next meeting about whether any signs of that worrisome dynamic would be forming.
04:08And I haven't seen them yet.
04:09And the recent prints on both inflation and the labor market didn't really change that picture for me at this
04:15point.
04:15There's been kind of a paradox forming right now where you've seen inflation above target for more than five years
04:21at the same time that the labor market seems to be kind of meh.
04:24I mean, it's OK, but people keep talking about low hire, low fire, and that that kind of dynamic with
04:31real wages not keeping pace for the past five years will lead inflation to go lower.
04:36Why hasn't it right?
04:37I mean, when does that relationship reassert itself?
04:41Well, one of the things that is true is that we've had many periods in our history with, you know,
04:46essentially, if you're thinking in economics terms with the Philip curve is very flat and you just don't see the
04:50relationship between the labor market and price inflation.
04:53And it also kind of illustrates why the shocks have been a big component of overall inflation, you know, the
05:00tariff shock, the oil price shock, and now the AI investment boom shock.
05:04And in all of those, you have to ask, what is the expectation of their duration?
05:09Are they spreading to other sectors than the ones that they directly affect?
05:13And what do we think they will do if they, you know, compound with each other?
05:18Will that make a difference or will it not?
05:20So I think that's what's really driving it.
05:21I wouldn't look to the labor market.
05:23You don't see any signs that the labor market is contributing to inflation.
05:27And I really think at this point you have to look at these other factors because that link between, you
05:34know, wages and price stability is often weak.
05:38We came off a period where it was very strong because we saw a very frothy labor market, very strong
05:43labor market, and people were saying that they were worried about a wage price spiral.
05:47I think I've talked to you both about that.
05:49But we're way past that, and now we have to look at these other factors driving inflation.
05:55And so I'd say the main contributor to why inflation has persisted for so long, even when we've had restrictive
06:01policy, is because we have these shocks.
06:04And then, of course, service price inflation is just stickier.
06:07It takes a while to come down.
06:09President Daly, I'm just going to keep our audience on top of the moves we're seeing of the bond market
06:12at the long end of the curve, up by close to seven basis points, 30s at the moment if you
06:16bring up the board.
06:17Around 526, yield tire through the levels.
06:21This is important.
06:22And we've taken back much of the rally, in fact, all of it, since we had that Treasury announcement this
06:27time yesterday at 8.30 Eastern time.
06:29Of the back of this move in the bond market, equity futures lower by 0.6% on the S
06:33&P 500.
06:34President Daly, I can imagine you'd love to avoid all the conversation about Treasury, the department and issuance.
06:40But forgive me, I have to go there.
06:41There are many people who believe we'll see a continuation of this Treasury Department under Scott Besson, of the policies
06:48that we saw under Janet Yellen, and that we'll see less issuance at the long end and more supply at
06:54the front end.
06:54If T-bill issuance continues to climb and account for more and more of the issuance coming from the Treasury,
07:00President Daly, how does that view, how does that change your view on what to do and what not to
07:04do with policy?
07:05What does it mean for the everyday workings of the Federal Reserve, who is very focused on managing short-term
07:10rates?
07:12Well, I'd say these are early days, and I wouldn't want to be preemptive in sort of discussing those types
07:17of things until we've had a chance to think through those issues.
07:20But, you know, the Treasury Secretary is different than the Fed.
07:24The Fed is talking about price stability and full employment.
07:26And what I do know, and we've historically been able to do this, is that we have a goal, and
07:32we can achieve those goals through our policy implementation, and we will find a way to do the job that
07:38Congress gave us, which is restore inflation to 2 percent, our goal as we define it, and do that price
07:44stability.
07:45So I think we don't want to worry about the mechanics of how to do that as much as the
07:49commitment to achieve it.
07:51Forgive me for going there, but is it in conflict with what you're trying to achieve when you see the
07:56Treasury Department attempt to manage prices and yields?
07:59Ultimately, I think this is really important, but it's the Treasury Secretary's job, not the Federal Reserve's job.
08:05And we have our own job, which is very important, but also we're not quite there yet, so I'm going
08:10to focus there.
08:10The Treasury Secretary at the moment, and you'll forgive me for pushing, is actually trying to influence financial conditions.
08:17You could see that yesterday, yields came in.
08:19You could see the dollar weakened as well.
08:21Given the moves happening elsewhere in financial markets, particularly in crude, you do have to wonder, President Daly, if that's
08:27an increasing challenge for the Federal Reserve that they might have to confront.
08:31It sounds like that's something you're interested in, but again, I really am in the – I work for the
08:36Federal Reserve, and I think importantly – and I'm pushing back in this.
08:41The important thing the American people need to know is that the Federal Reserve cares about its independence and its
08:46credibility and sticks to its remit.
08:48You know, we take in all the information, we look at everything, because those are important inputs, but we know
08:54what our job is, and we focus on doing that.
08:57And that, you know, if you want to talk about inflation compensation and expectations and Fed credibility, I'm happy to
09:02talk about those things, the labor market.
09:04But I really do think that with our job right in the importance area here, and we aren't meeting our
09:11target yet, we really have to focus there.
09:13President Daly, how would you characterize right now the overall economy?
09:17I mean, we've talked about how there is this sort of heat coming, but right now, do you think that
09:22it's solid?
09:23Do you think it's expanding?
09:24Or do you think that it's decelerating?
09:26You know, what I'm really seeing, and it's an interesting time, you know, I think people say it's confusing.
09:31There's contradictory data.
09:34It is true that the typical historical ways we think and measure the economy, the dynamics and the interrelationships don't
09:41seem to be squaring up like they would typically do.
09:44So then what do you think?
09:45What do you look at?
09:46When you talk to businesses, they're cautiously optimistic, and they're cautiously optimistic beyond the AI sector where they're just optimistic.
09:54And they're optimistic.
09:56They think of this.
09:56They call it an industrial renaissance.
09:58We are in the next industrial revolution.
10:01So they have all that enthusiasm.
10:03But what I really watch is what are other businesses saying?
10:06What are other businesses thinking?
10:08And they're focused on the fact that consumers are trading down and feeling a little bit tighter in their pocketbooks
10:14than their spending.
10:14But they're also focused on they keep coming to their business.
10:17They keep wanting to do things.
10:19And importantly, I start to see these businesses, I'm seeing these businesses using AI, really working hard to see how
10:27can this technology, which is in the development stage, really, how can it affect their business processes, even the physical
10:35world that they work in?
10:36And what can they do to make things better?
10:38So I'd say that there's all this enthusiasm about the future and a lot of anxiety about the present.
10:45And that is a colliding piece.
10:48Now, if you talk to the consumer, they're still there.
10:50They're still spending, although it's slowing and they're trading down.
10:54But they do feel more precarious.
10:56You can see that in the sentiment surveys, either of confidence or workers.
11:00And I think it's in this low fire, low hire environment that they feel it's an uncomfortable stability.
11:07It's an uncomfortable stability that we're not really accustomed to.
11:10But the the policymaker is a policymaker.
11:14We have to ask, is it sending any weakening signals?
11:18Do we see any sense that things are fragile?
11:21And I just don't see that yet.
11:22And you saw that in the claims data today.
11:24You just don't see signs that the labor market is faltering.
11:27You simply see signs that it's it's running around at a very low level.
11:33And the most important question I'm asking CEOs right now about the labor market is where are your, you know,
11:40cutting back plans?
11:41You were in a low hiring, low firing.
11:44But do you have those plans moved to the front of your desk?
11:46And are you watching them carefully?
11:48And right now they're there.
11:49They know what they would do.
11:50But they still see that cautious optimism of trying to meet output growth where it is and be not the
11:56last in line to do that, the first in line to do that.
11:59President Daly, you mentioned artificial intelligence and the idea that a lot of these companies were trying to deploy AI
12:04tools in lots of creative ways.
12:06Right now, is it still more inflationary that it is that it is disinflationary in terms of productivity?
12:11Is that something that the Fed needs to combat or address or is that something that the Fed can look
12:18through with the hopes that there will be more productivity on the other side?
12:22This will all come down to something that we have to watch, which is, is this a relative demand shock?
12:27Is it changing the relative price of technology goods or is it spreading more generally into think of data center
12:33build outs?
12:34Is that pushing up the price of construction workers everywhere or is it simply, you know, you're getting specifically trained
12:41people or people are coming to do those things right now?
12:44I'm not seeing a broad spillover in the broader inflation measures.
12:48I am seeing a rise in software and technology goods.
12:52Those are pushing up, but that's a relatively small sector of the overall price indices.
12:56And so I haven't seen evidence of that, but that's what we would have to watch.
13:00And so the investment growth is very, very strong, and that's affecting interest rates, as you as you see, long
13:06dated yields.
13:07But you don't see that pushing itself into price inflation writ large, although you definitely see it if you're trying
13:13to buy a high end technology good.
13:15You see some effect there.
13:16So we'll watch that whether that spills over into consumer prices, consumer goods and services.
13:22So far, haven't seen a lot of that.
13:24But we will. That's definitely if you're if your coffee maker starts rising in price because the chips that go
13:30in it, if you buy one of those new fancy ones, then if that starts going up, that's a sign
13:34of broader based problems or automobiles.
13:37But yet we haven't we haven't seen that of yet.
13:40President Daly, you've mentioned that policy is in a fairly good place right now as all of the members look
13:46at the incoming data.
13:47Is there anything that's transpired that makes you question that or has the data been more of the same to
13:52indicate that the Fed is in a good place to keep watching the data for a while longer?
13:58I'm on the latter point you made.
14:00I think we're still in a good place to keep watching the data.
14:03As I mentioned, you know, the two prints that have come out on inflation in the labor market didn't make
14:07didn't really clear much up for me.
14:10You know, I'm not going to get on the bandwagon of see we had a softer inflation print.
14:14We should stop worrying about the risks of higher inflation.
14:16I don't think that's right.
14:17And I don't think the labor market print suggested that there's any, you know, impending weakness there.
14:24But we have to continue to watch these things.
14:26And importantly, I think with inflation elevated for as long as it has been, we have to constantly discipline ourselves
14:33to watch what's happening to inflation expectations.
14:36What's happening to producer instinct to raise prices?
14:41Are they able to right now?
14:42They say they're not.
14:43They're really not pushing all their input cost increases through to prices, consumer prices.
14:49So those are the dynamics to watch and continue to watch the labor market.
14:53But if I look at the two, we are missing on our inflation goal quite a bit.
14:58And the labor market is relatively stable.
15:00So a lot of my attention is on that inflation miss and how to get this back down to 2%.
15:06And when do I have a sufficient amount of confidence to say we're on our way right now?
15:11I think that's the modal view, but I don't think it's so modal.
15:15The probability isn't so large on that front that you can't watch these risks.
15:19And I think it's so large on that.
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