Dallas Fed president Lorie Logan said Monday that the Fed may have to do more to cool inflation if the economy continues to surprise to the upside, pushing up long-term bond yields.

"If long-term interest rates remain elevated because of higher term premiums, there may be less need to raise the fed funds rate," Logan said in a speech in Dallas at the National Association for Business Economics annual meeting, pointing to the recent spike in long-term bond yields.

"However, to the extent that strength in the economy is behind the increase in long-term interest rates, the FOMC may need to do more."

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Logan said she expects the Fed will need "continued restrictive financial conditions" to bring inflation down to the Fed’s 2% target in a timely way.

Another Fed official also warned Monday that a stronger economy and job market may fuel inflation. Fed vice chair Philip Jefferson said at the same conference the Fed needs to move cautiously in determining whether to raise interest rates again, though he’s "particularly attentive" to upside risks to inflation, including whether the economy and job market remain too strong to push inflation further down just as energy prices have unexpectedly risen.

"We are in a sensitive period of risk management, where we have to balance the risk of not having tightened enough, against the risk of policy being too restrictive," Jefferson said during a speech in Dallas at the National Association for Business Economics’ annual meeting. "The balancing of these two risks was a good reason for holding the policy rate constant at our most recent FOMC meeting."

Looking ahead in determining policy, Jefferson says he’s watching higher long-term bond yields as well as jobs and inflation data and taking into account lag effects. With the bulk of corporate debt issued by large firms yet to be refinanced since the Fed started raising rates, Jefferson sees that as additional tightening from the Fed’s previous rate hikes still in the pipeline.

Logan is also attentive to higher bond yields. In trying to understand what’s driving the latest movements in yields, Logan says her back-of-the-envelope estimates suggest that more than half of the total increase in long-term yields since the July Fed meeting reflects rising term premiums.

The term premium is the amount by which the yield on a long-term bond is greater than the yield on shorter-term bonds. The premium reflects the amount investors expect to be compensated for lending for longer periods.

Logan noted the economy has shown surprising resilience over the past year in the face of sustained real interest rates — rates adjusted for inflation — north of 1.5%.

"I’m starting to take some signal from that resilience, not only about the rates needed to restore price stability in the next few years but also about the rates that will need to prevail to sustain price stability and maximum employment over a much longer horizon," she said.

Logan noted that the bond market could do some of the Fed’s work for it by cooling the economy. She expects that as the Fed continues to shed Treasuries from its bloated balance sheet, it means more investors will be required to hold Treasuries instead of the Fed, contributing to higher yields.

The bond market is closed for Columbus Day on Monday, but the yield on the 10-year Treasury has soared by nearly 80 basis points since August, nearly knocking on the door of 5% Friday — the highest level since 2007.

Both Logan and Jefferson noted that even though recent inflation data have been encouraging, inflation remains too high.

And while the job market isn’t as hot as it was a year ago, it remains very strong overall. The US economy has been adding more than 250,000 jobs per month, more than enough to keep pace with trend growth in the labor force, according to Logan.

Jefferson said the job market remains tight and that despite the strong September jobs report from last week, there’s evidence that the imbalance between demand for jobs and supply of workers continues to narrow, as labor demand cools while labor supply improves.

The Fed voted to hold rates steady in its September policy meeting but kept the door open for one more rate hike. Officials are heavily data dependent. A surprisingly strong jobs report for the month of September has markets toying with higher odds of another rate hike if another closely watched measure of inflation this week comes in hot.

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