Fed's Paulson Open on Rates as Core Inflation Runs at 2.4%-2.8%

The Fed's 2026 voter Anna Paulson said she remains open-minded on the rate path, with core inflation at 2.4%-2.8% versus the 2% target, days after the FOMC held rates for a fifth straight meeting.

"Recent improvements in some inflation data are encouraging — a step in the right direction, but only a step," Paulson wrote in an essay published Tuesday. She emphasized that core inflation has remained elevated for an extended period, making it the key metric she watches when assessing policy progress.

The FOMC left the federal funds rate at 3.5%-3.75% at its July 29 meeting, the fifth consecutive hold. Three officials dissented in favor of a 25-basis-point hike, arguing modest tightening would reduce the risk of needing larger moves later. June core PCE rose less than expected, with the headline PCE index falling 0.1 percent month-over-month, while inflation-adjusted consumer spending climbed 0.4 percent — matching the strongest pace since July of last year.

Paulson's stance diverges from the three hawkish dissenters — she did not endorse a hike, instead anchoring her decision to incoming data. With the next FOMC meeting in September, the trajectory of core inflation over the coming months will determine whether the current rate level proves sufficiently restrictive or whether further tightening is needed.

Two Scenarios, One Data Point

Paulson outlined two possible paths. If inflation continues to improve and expectations remain anchored, the current rate level may already be "moderately restrictive" enough to return inflation to target within a reasonable timeframe. But if core inflation stays stubbornly high, current policy may be insufficiently restrictive, requiring further tightening.

She also flagged two opposing external forces. Middle East conflict is creating uncertainty and upward pressure on inflation, while the artificial intelligence infrastructure buildout is lifting prices in some sectors but also driving overall economic growth. These crosscurrents complicate the policy calculus, as the net effect on inflation and growth remains unclear.

The labor market, by contrast, is providing no additional pressure on monetary policy. Paulson said employment conditions remain stable, giving the committee room to focus on the inflation side of its dual mandate. Consumer spending data supports this picture — the 0.4 percent monthly gain in real spending suggests demand resilience that could keep upward pressure on prices even as headline inflation cools.

Fed Communication Adds to Uncertainty

The open stance comes as the Fed under Chair Kevin Warsh has adopted a more restrained communication approach, offering little forward guidance. Mark Zandi, chief economist at Moody's Analytics, warned that this limited visibility into the Fed's reaction function could increase market volatility, with investors potentially misjudging the central bank's next move.

Zandi noted signs this uncertainty is already affecting markets through a rising term premium, which has contributed to higher long-term interest rates and a less stable equity market. He warned that a future policy meeting could trigger a significant sell-off if the Fed continues to provide minimal guidance, tightening financial conditions and potentially weighing on economic growth.

Three dissents at a single meeting is a relatively rare occurrence for the FOMC, and the split reflects genuine disagreement over inflation risk. Paulson's data-dependent posture leaves the door open in both directions, but the hawkish tail risk — that core inflation stays elevated and forces additional tightening — is now a scenario markets must price.

For investors, the widening spectrum from hawkish to wait-and-see within the FOMC makes the near-term rate path harder to price. Each inflation and employment report before the September meeting will carry outsized weight as markets try to gauge whether the current hold is the peak or a pause before further tightening. Fresh inflation and employment data are due before the September FOMC meeting, giving policymakers and markets a clearer picture of whether the disinflation trend is durable.

This article is for informational purposes only and does not constitute investment advice.