San Francisco Fed President Mary Daly Explains the 'Hawkish Cut'

Episode Summary

Executive Summary: Mary Daly argued the Fed’s 25bp “hawkish cut” was a recalibration from highly restrictive to moderately restrictive policy, not a shift toward easing. She said inflation is still sticky, driven more by housing and non-market prices than labor, while the labor market is balanced. She also discussed higher neutral rates, AI-led productivity, tariffs, and why Fed voters matter less than the quality of arguments.

Main Topics: Why the Fed cut despite sticky inflation (Priority: 5/5): Daly said policy had been highly restrictive and needed to move to a more moderate level to avoid damaging jobs as inflation and labor markets normalized. Residual sources of inflation (Priority: 5/5): She identified non-market prices and housing services as the main remaining inflation pressures, with housing especially persistent due to supply shortages. Market reaction to the hawkish cut (Priority: 4/5): She said the market’s selloff after the FOMC decision was surprising, though markets were already pricing fewer cuts than the Fed’s earlier forecast. Higher neutral rate and structural changes (Priority: 5/5): Daly argued the neutral rate has likely risen because of lower global savings, higher investment demand, AI-related capex, and persistent government borrowing. Labor market balance and model performance (Priority: 4/5): She said the labor market is now balanced and defended standard models, citing the Beveridge curve and a flatter Phillips curve as working well post-pandemic. Tariffs, trade, and the incoming administration (Priority: 4/5): She declined to forecast Trump policy specifics, but said tariffs and other changes could have complex, non-transitory effects depending on scale, timing, and retaliation. AI, productivity, and measurement lags (Priority: 4/5): Daly said AI is already boosting productivity in real operations, but measured productivity may lag, similar to the early computer revolution.

Key Arguments: The rate cut was justified because policy had moved from fighting severe inflation to a point where leaving rates too high could cause a hard landing. Inflation’s remaining pressure is less about wages and more about housing shortages and difficult-to-measure non-market prices like financial services. Markets overreacted to the FOMC dots because the dispersion of forecasts was wide and the difference between two and three cuts is modest. The neutral rate is likely higher than pre-COVID because global savings are lower, investment demand is stronger, and AI/automation are spurring spending. Fed models still work: vacancy-to-unemployment dynamics improved without a sharp rise in unemployment, and the Phillips curve appears flatter. The Fed should not speculate on incoming administration policy before details are known; it should assess the net effects after proposals become concrete. AI is already being adopted broadly across industries and may raise productivity materially, but the impact will take time to show up in official data. A soft landing should be judged by whether workers, especially lower-paid ones, have time to recover real income losses from the inflation surge.

Data Points: Fed rate cut: 25 basis points - The FOMC reduced rates at the December meeting. Expected cuts next year (Fed dots): 2 - Daly discussed the new 2025 forecast and the market reaction. Market-priced cuts next year: 3 - She said markets had been pricing fewer cuts than the September Fed forecast. September Fed expectation: 4 cuts - She referenced the earlier September SEP projection. Market reaction timing: December 20 - The episode was recorded two days after the FOMC decision. Labor market vacancy-to-unemployment ratio: 1:1 - Daly said vacancies have come down while unemployment remained stable. San Francisco Fed district: 9 states + 3 territories - She described the 12th District coverage. Territories named: Guam, American Samoa, Northern Mariana Islands - She answered the hosts’ quiz about the district. Core PCE surprise: 0.1% m/m vs 0.2% expected - The hosts interrupted with a live inflation print during the interview. Year soft-landing assessment: 2 years - The hosts referenced the period over which sentiment and inflation conditions evolved. Year ChatGPT was announced: 2022 - Daly used it as a marker for the AI wave. Target inflation: 2% - Repeated reference to the Fed’s inflation objective. Possible timing for reaching target: 2027 - Referenced in the setup to the interview as part of the hawkish-cut discussion.

Pivotal Quotes: "“Otherwise, what you end up doing is breaking the economy.”" — Mary Daly: Explaining why the Fed cut rates despite slower progress toward 2% inflation. "“We’re not a data point-dependent Fed, we’re data-dependent.”" — Mary Daly: Reacting to the live core PCE release and stressing a broader, not single-point, approach. "“It’s a feature, not a bug.”" — Mary Daly: Describing the wider dispersion in FOMC dots and forecasts as appropriate under uncertainty.

Implications: The Fed likely stays cautious: cuts have slowed, inflation may remain sticky, and future policy depends on housing, trade, AI, and fiscal forces. Investors should expect a higher-rate regime than pre-COVID and more volatility around policy and data.