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Inflation will reach 2% slower than Yellen predicts: Economist

In an exclusive interview with Yahoo Finance on Monday, Treasury Secretary Janet Yellen expressed optimism about inflation, projecting it would reach the Federal Reserve's 2% target by 2025. To provide further insight into this economic outlook, Bank of America Securities managing director and chief US economist Michael Gapen joins Morning Brief.

Gapen agrees with Secretary Yellen's assessment but offers a slightly more conservative timeline. He suggests that the 2% inflation target "may be achieved in 2026, not 2025." However, Gapen anticipates a downward trend that could pave the way "for a gradual rate cut cycle later this year," cautioning that the process might unfold "a little more slowly than Secretary Yellen suggested."

Addressing the broader economic picture, Gapen told Yahoo Finance, "Obviously nothing is assured, of course, but we do think that every quarter that goes by... every set of data we receive, does increase the probability that the US is achieving a soft landing."

Watch Yahoo Finance's full interview with US Secretary of the Treasury Janet Yellen here.

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For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Angel Smith

Video transcript

We're also tracking investors shifting their focus to the next set of inflation data.

P ce is on tap Friday, over 60% of traders still anticipating a rate cut to come in.

September our own Jennifer Schoenberger asked Treasury Secretary Janet Yellen in an exclusive interview about the path forward for inflation.

Here's what she had to say.

I do expect inflation to come down.

And as we get into next year, I believe that inflation will uh go back to uh the fed's 2% target.

Our next guest is expecting a slightly slower routes to that two percent mark Michael Gapen B of a securities head of us economics joins us now, Michael.

Great to see you.

Great to get some insight.

You heard from the Treasury Secretary there.

What are your anticipations as to when we could see us finally getting to that 2% target?

Yeah, I think we largely agree with what Secretary Yellen said.

We we think it'll come a little later.

We think 2% may be achieved in 2026 not 2025 but we don't agree.

We don't disagree with with the trajectory.

We do think inflation is coming down.

But Secretary Yellen also noted in her interview that a lot of the stickiness about inflation was centered around housing and housing related costs.

Um Those are likely to be elevated for some time.

But directionally, yes, we think inflation will come down.

We we do think it opens the door for a graduate rate cut cycle later this year.

We just think how things happen a little more slowly than Secretary Secretary Yellen suggested.

So would rate cuts then if we were to see that later this year and even going into 2025 would that hinder being able to get to that 2% target by 2026?

Not necessarily because the, the way that the FED has laid this out is to say yes, they would likely be reducing rates later this year.

But the pace of rate reductions would be gradual and the way they think about it is inflation has come down an awful lot and in essence, you can cut interest rates and keep and preserve a real policy rate stand.

So adjusted for inflation, the Fed's policy setting would be largely unchanged.

So what essentially they would be doing is cutting rates to prevent policy from getting too tight over time.

And so they, they can still guide inflation down to 2% from above even though they're gradually reducing rates.

So they'll maintain their existing policy stance by cutting interest rates gradually.

So, Michael, what does that then?

Do just to the overall US economy.

We talk about the fact that growth is already moderating.

Are you still confident that the FED is going to be able to orchestrate a soft landing?

And obviously nothing's assured of course.

But we do think um that every quarter that goes by kind of every set of data we receive does increase the probability that the US is achieving a soft landing, right?

And the key there is essentially how much to use the fed's term.

How much pain do you need to inject into labor markets?

How much demand destruction do you need to create?

In order to bring inflation down, we haven't needed much of of that.

So every, every month, every quarter that goes by and and growth is elevated and the unemployment rate stays low, but inflation comes down.

I think the FED is winning the battle in terms of creating a soft landing.

Nothing is guaranteed, of course, but we do think it's the most likely outcome.

What, what would be the reality of the consumer environment and, and that need to move too in order for the FED to see what it needs both on the inflationary side, but also on the employment side as well as many consumers just look back to the strength in employment to figure out how confident they are to continue to spend, right?

And so I think kind of the nuance with this whole story, of course, is we we expect growth to moderate.

We expect the catch up effect in employment to slow as the services sector finally achieves the the level of employment that that it desires.

So the rate of consumption growth should slow, the rate of economic growth should slow.

These should all move back to more, you know, quote normal levels, which is around 2% which is still plenty to keep the US in an expansion phase and in a recovery, it just won't be the 3 to 4% or 5% real growth rates that we saw in in prior years.

So I I think the outlook is a little less employment growth, a little less wage growth, but still enough adjusted for inflation to keep the consumer balance sheet healthy overall.

Um But as you noted, the economy is cooling, it's just not cool.

Overall, the labor market is cooling, it's just not cool overall.

That's, that's kind of the balance in here.

We should expect things to moderate, but it doesn't mean the economy is weakening.

It's just normalizing coming out of the pandemic.

All right, Michael G be always great to talk to you.

Thanks so much for making the time to join us here this morning, Bank of America's head of us.

Economic, thanks so much.