Fed’s Paulson backs further ‘gradual’ rate hikes as inflation remains high

At the Federal Reserve Bank of Philadelphia's 81st Annual Field Meeting Capstone, Federal Reserve (Fed) Bank of Philadelphia Governor Anna Paulson gave a speech.

Key remarks

A deterioration in the inflation outlook would prompt more aggressive action from the Fed.

With inflation elevated, additional ‘gradual’ rate increases are appropriate.

How the economy develops will determine the precise course of interest rate policy.

A ‘somewhat restrictive’ monetary policy stance is needed.

By raising rates gradually, Fed officials have also had room to assess the impact.

The economy has had time to adapt to gradual increases in interest rates.

The data indicated that inflation continues to pose a problem.

Has backed the Fed’s latest interest rate decisions.

Between 2.5% and 3%, underlying inflation remains entrenched.

To bring inflation down, the Fed has ‘more work to do’.

Economic strength has exceeded expectations, while the labour market remains resilient and stable.

Risks to the inflation outlook remain high, with the effects of AI and energy on inflation difficult to assess.

How are markets responding?

Gains driven by the hot Consumer Price Index (CPI) reading are consolidating in the US Dollar Index (DXY), which is trading near 102.25 at the time of writing.

Could inflation risks keep rate hikes on the table as Fed’s Paulson strikes a hawkish tone?

A bias towards further tightening emerged from Fed’s Paulson’s distinctly hawkish remarks. Her FXS Speechtracker score of 8.1/10 exceeded the historical average of 7.6/10, highlighting a firmer stance than the established baseline. Support for further “gradual” rate increases and “somewhat restrictive” policy pointed to additional tightening, while her assertion that the Fed “will move more aggressively if inflation landscape worsens,” left scope for swifter action. With underlying inflation entrenched between 2.5% and 3%, the economy stronger than anticipated and inflation risks elevated, her message was that the Fed has “more work to do,” a mix that typically supports the Dollar while weighing on risk-sensitive FX.

The broader Fed communication backdrop remained firmly hawkish, as the FXS Fed Sentiment Index held at an elevated 145.28 following a 0.00-point daily change. Although Paulson’s FXS Speechtracker score exceeded the baseline, the index’s unchanged reading suggests that markets had already largely factored in a restrictive stance. Its elevated level nevertheless maintains upward pressure on the Dollar against lower-yielding peers.