The Federal Reserve’s dual mandate is to foster full employment and price stability in the United States. The Fed has a 2.0% to 2.5% target for inflation. Sure, 2% and under would be preferred. But what happens when the very data-dependent Fed has to start incorporating foreign inflation into the mix?

It may not seem surprising that inflation in other developed markets would signal many of the same inflationary risks in the United States. How intertwined the inflationary magnets are tied might be surprising. The United States is still the top economy in the world and the U.S. dollar is still the world’s reserve currency.

The San Francisco Federal Reserve Bank published a new letter titled International Influences on U.S. Inflation. Its fresh post-Covid analysis shows that the international component of U.S. inflation is usually small in normal times. It also shows international inflationary pressures can contribute significantly to U.S. inflation dynamics at “other” times.

Here is where the big inflation data in the San Francisco Fed’s report will hurt — International inflation was shown to have added about 4 percentage points to the rise in U.S. goods prices during the pandemic. The international pull then also accounted for 3 percentage points to the decline in U.S. goods prices since 2023.

While this is targeting the goods (stuff), there appears to be a smaller effect on the prices of services in the U.S. economy. And the report also notes that a the “global soft landing” which has been recently touted by the International Monetary Fund may continue to push U.S. inflation lower.

This recent Fed letter studied 13 advanced economies: Australia, Belgium, Canada, Denmark, France, Ireland, Italy, Japan, Luxembourg, Netherlands, Portugal, Sweden, and the United Kingdom. Outside Australia and Japan, this report is focused mostly on Western nations. The words “China” and “Asia” are not mentioned once in the summary. That seems odd considering where so many of the goods coming into the U.S. are coming from.

Its conclusion is that services are more insulated than the goods as goods are the most exposed to international trade. It further concluded:

Our model suggests that, although domestic Phillips curve factors are the primary drivers of U.S. inflation during normal times, international factors can occasionally boost or dampen domestic inflation. These results are further corroborated by analyzing the components of U.S. inflation.

The report might not be a surprise to those who understand how markets are so linked around the world. We all found out just how much during the pandemic. That said, this may lend credence to yet another dilemma the Federal Reserve faces when it is so data-dependent AND trying to lower interest rates back to normalized levels.

The Fed never really has the liberty to ignore international events that could shock U.S. markets and the mighty U.S. economy. But now, perhaps, it means the Fed may also have to include major international Consumer Price Index releases almost as much as it is looking at the CPI reading in the U.S.