Fed’s Paulson Backs Gradual Hikes, Warns Core Inflation Stuck Above Target

Fed’s Paulson Backs Gradual Hikes, Warns Core Inflation Stuck Above Target

TREE NEWS reports: Philadelphia Fed President Anna Paulson, a 2026 FOMC voter, said on Tuesday that she supports a gradual path of further interest-rate increases, but issued a stark warning: core inflation remains persistently above the 2% target and shows no sign of retreating. Her comments came as several other Fed officials struck a more hawkish tone the same day, signaling a deepening split within the central bank over the pace of tightening ahead of the December meeting.

The debate was fueled by October inflation data showing core CPI—which excludes food and energy—rose 0.3% month-over-month, exceeding expectations. Paulson said the report confirms price pressures are “very real” and that core inflation is “stuck” between 2.5% and 3%. The Fed paused last month in a 10-2 vote, keeping the benchmark rate at 3.75%-4%, after a unanimous 25-basis-point hike in September.

Gradual Approach Preferred, But With Triggers

“For now, further gradual tightening seems appropriate,” Paulson said at an event hosted by the Philadelphia Fed. She noted that wage pressures remain limited and inflation expectations are still anchored to the 2% goal, giving room to slow the pace. She laid out clear conditions for accelerating: “If inflation expectations move up, wage pressures build, or core inflation moves higher, I would want to act more quickly. But that is not what I am seeing.”

She argued that a slower pace allows households, businesses, and financial markets time to adjust while giving policymakers room to assess data. “A gradual approach works best when the direction of policy is well understood by markets,” she said. “If markets expect more tightening, gradual moves will not leave us behind the curve.” She also explained that skipping a meeting is a matter of pace, not direction.

Inflation ‘Stuck’: Tariffs, Energy, and AI Demand

Despite favoring gradualism, Paulson’s inflation assessment was downbeat. She listed multiple factors pushing prices higher: tariffs, energy costs driven up by the Iran war, and demand pressures from a data-center construction boom. While tariff effects are fading, she said energy supply and AI-related demand are “harder to judge.” “The conclusion is clear: core inflation is above target and not falling. That tells me elevated inflation is not merely due to factors that will fade on their own,” she said.

On the labor market, she said it continues to strengthen and resilient consumer spending is supporting the economy. She mentioned isolated reports of businesses considering wage increases to address cost-of-living pressures but stressed “nothing in the data suggests this is widespread.”

Hawkish Voices: Waller, Logan, Schmid

In contrast to Paulson’s gradualist stance, several officials sent stronger signals. Fed Governor Christopher Waller, speaking in London, said if October core CPI holds at around 0.3% or higher, “more forceful policy action may be needed,” and the December meeting should consider a 50-basis-point hike. He warned that “only 25 basis points would put our credibility at risk, and that is a risk I am not willing to take.” Waller said the Fed needs to at least recoup its three “insurance cuts” but would not raise rates by 150 or 200 basis points.

Dallas Fed President Lori Logan said, “It is clear to me that the FOMC needs at least two more 25-basis-point hikes,” hinting that the pace could quicken this winter. Kansas City Fed President Jeff Schmid said in Houston, “I did not think our rate was restrictive last year, and I think it is quite accommodative today,” emphasizing inflation as the top policy risk. Fed Governor Michelle Bowman also spoke, warning of risks from an AI-driven “sharp correction in equity valuations” and a “sharp rise in private long-term interest rates,” while suggesting she could support a December hike.

Market Implications

The divided Fed message complicates the outlook for all asset classes. For stocks, the prospect of a 50-basis-point hike in December could pressure rate-sensitive growth and tech names, especially if Bowman’s warning about AI-driven valuations materializes. Bonds face renewed volatility as traders reassess the terminal rate; a faster hiking path would steepen the curve and push short-term yields higher. The dollar could strengthen on hawkish signals, weighing on commodities and emerging-market currencies. Gold may find support from inflation-hedge demand but could be capped by higher real yields. For crypto, tighter liquidity and rising rates are typically headwinds, though persistent inflation could bolster the “digital gold” narrative if confidence in the Fed’s credibility erodes.

Key Takeaways for Investors

• December hike odds are rising—a 25-basis-point move is increasingly priced, but a 50-basis-point outcome is now a live possibility, creating event risk.
• Inflation is sticky—core CPI stuck at 2.5%-3% suggests the Fed cannot declare victory, keeping policy restrictive for longer.
• Watch the Fed’s credibility—Waller’s explicit warning about credibility underscores the risk of a sharper tightening if inflation expectations slip.
• Sector rotation—rate-sensitive sectors like housing, small caps, and unprofitable tech may underperform; value and energy could benefit from persistent inflation.
• Diversify—with both inflation and rate uncertainty elevated, investors should consider inflation-protected securities and maintain duration discipline.