Fed officials diverge: one sees only modest rate adjustments ahead, another warns inflation risks remain tilted to the upside

Divisions within the Federal Reserve over the future trajectory of interest rates are widening. As the U.S. economy remains resilient and the labor market shows no signs of a sharp slowdown, Philadelphia Fed President Anna Paulson has suggested that the central bank may only need to make "moderate" rate adjustments if inflation continues to decline. In contrast, Cleveland Fed President Beth Hammack has warned that inflation risks remain tilted to the upside, cautioning policymakers not to underestimate price pressures.

The contrasting remarks highlight a core dilemma facing the Fed: economic growth has yet to slow significantly, while the path back to the 2% inflation target remains uncertain.

Following the Fed's September decision to raise the federal funds rate target range to 3.75%–4.00%, markets had anticipated a gradual shift toward looser monetary policy. However, recent economic data and official commentary suggest the Fed is still weighing the balance between "maintaining tightness" and "making moderate adjustments."

Paulson: Moderate Adjustments Possible If Inflation Continues to Fall

Paulson stated that current monetary policy is already somewhat restrictive and is helping to ease price pressures. If the economy evolves as expected—with inflation continuing to decline and the labor market remaining stable—the Fed may only need to implement "moderate" rate adjustments in the future.

She emphasized that the Fed will continue to adjust policy based on incoming data, without pre-committing to any specific path. In the current environment, she argued, policymakers must remain open-minded and monitor risks related to both inflation and employment.

In her view, the U.S. economy is not showing significant imbalances. While the labor market has cooled from its post-pandemic peak, it remains stable. Inflation has also fallen from its peak levels, suggesting that monetary policy should avoid excessive tightening.

However, Paulson noted that future inflation trends remain subject to multiple factors, including energy prices, trade policy, supply chain developments, and geopolitical risks. Should these factors cause price pressures to re-emerge, the Fed would need to adjust its policy stance accordingly.

Hammack: Inflation Risks Still Tilted to the Upside; Premature Easing a Concern

In contrast to Paulson's emphasis on policy flexibility, Hammack expressed stronger concerns about inflation risks.

Hammack stated that the U.S. economy remains quite resilient, with the labor market near full employment. However, inflationary pressures have not fully dissipated. She warned that inflation risks are still "tilted to the upside," and that prolonged high inflation would make it more difficult to eventually return to the 2% target.

She argued that the Fed must pay attention to the persistent impact of potential supply-side shocks. Energy price volatility, geopolitical risks, and cost pressures could drive businesses to raise prices. If these factors influence inflation expectations, price pressures could become more entrenched.

Her views align with those of other recent hawkish officials. Boston Fed President Susan Collins previously expressed support for the Fed's rate hike decision and warned that inflation could remain significantly above the 2% target.

Collins believes that, given the resilience of the labor market, the Fed can focus more intently on ensuring price stability.

Economic Data Reinforces a Picture of Resilient Growth and Unresolved Inflation

Recent U.S. economic data is adding complexity to the Fed's policy assessment.

Business activity continues to expand. The September composite PMI rose to its highest level in more than five years, with improvements in both manufacturing and services. Meanwhile, initial jobless claims fell to around 197,000, remaining near historic lows and indicating limited layoff pressure. These data points suggest the U.S. economy is not cooling rapidly.

For the Fed, this means policymakers have no clear reason to stimulate the economy through rapid rate cuts. On the other hand, upward pressure on input costs and selling prices persists, and inflation risks have not fully subsided.

As a result, the Fed faces a policy environment unlike typical economic cycles:

• If the economy slows significantly and the labor market deteriorates, the Fed may need to pivot more quickly toward easing.
• If the economy remains resilient while inflation declines slowly, the Fed may need to maintain restrictive policy for a longer period.

Additionally, a renewed rise in energy prices could feed through fuel, transportation, and production costs into consumer prices, further complicating the Fed's efforts to control inflation.

Hammack's warning underscores this risk: short-term supply shocks, if prolonged, could alter business and consumer expectations about future price trends.

Paulson, meanwhile, focuses on the need for balanced policy, cautioning against excessive tightening that could place unnecessary strain on the economy.