Fed expected to respond strongly to inflation, job market conditions, research shows

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SAN FRANCISCO (Reuters) – Investors and economists expect the U.S. central bank to respond “strongly and systematically”  to changes in inflation and the labor market, according to research published on Monday by the San Francisco Fed that underscores the current sensitivity of financial markets to U.S. economic data.

The Fed’s perceived responsiveness to economic data picked up notably in 2022, driven first by inflation data and, last year, by labor market data, based on the analysis of perceptions embedded in professional forecasts and in bond market moves published in the regional Fed bank’s latest Economic Letter.

The findings are in line with the Fed’s actual response to inflation, which rose in 2021 but did not trigger any interest rate hikes until 2022. They also track with the Fed’s reaction to labor market data, which weakened notably in the middle of last year and helped drive the Fed’s decision to cut the policy rate by a full percentage point starting last September. 

The Fed’s target policy rate is currently in the 4.25%-4.50% range. Recent weaker economic readings, including a survey released on Friday showing business activity fell to a 17-month low this month, have helped firm up market bets on two quarter-percentage-point reductions to the policy rate this year.

Worries about stalling economic growth appear to be outweighing fears of a resurgence in inflation, also evident in recent surveys, at least as far as market bets on how the Fed will react with monetary policy.

Interest rate futures contracts are currently priced for the first Fed rate cut this year to come in June, with the second to happen as early as October.

(Reporting by Ann Saphir; Editing by Paul Simao)