How will the US Federal Reserve wage its battle with inflation — by keeping interest rates elevated for longer, or by taking them even higher? Investors are fixated on this question, which has vast implications for bonds, stocks and the entire economy.
Longer would be better. But if financial markets don’t cooperate, the Fed might have to go higher, too.
By tightening monetary policy, Chair Jerome Powell wants to restrain demand for labor just enough — but not too much — to bring wage growth down to the 3%-to-4% level consistent with the central bank’s 2% inflation target. To that end, the best approach would be to hold interest rates at a moderately restrictive setting for a significant period of time. Given that rate hikes affect the economy with long and variable lags, this reduces the risk of going too far and increases the chances of a soft landing. The Fed can take its time as long as inflation expectations remain well-anchored.
