If Jay Powell needed further evidence to bolster the US central bank’s case for scaling back its enormous stimulus programme more quickly, he secured it on Friday with the release of November’s inflation report, which showed consumer prices rising at the fastest annual pace in nearly 40 years.
The consumer price index jumped 6.8 per cent in November from a year earlier and removed any doubt that ongoing price pressures are broad-based.
Even before the latest inflation reading, the Federal Reserve had already changed tack, abruptly shifting from a patient approach to scaling back the central bank’s ultra-accommodative monetary policy and instead assuming a much more aggressive stance against inflation. In it’s aftermath, the Fed appears on track to push forward with its plans.
Powell laid the groundwork earlier this month, stressing it was highly uncertain when inflation would moderate next year.
He also vowed to use the Fed’s tools to ensure inflation does not become entrenched — a pledge he backed up by signalling support for the central bank to wind down its asset purchases “perhaps a few months sooner” than the initial June timetable. Economists now expect the Fed to double the tapering pace and cease expanding the size of its balance sheet in March, setting the stage for a series of interest rate increases in 2022.
“The Fed’s communication has been quite clear: they will speed up the tapering and the purpose is to open the door to rate hikes next year,” said Anne Beaudu, global fixed income portfolio manager at Amundi.
Powell’s pivot came just four weeks after the Fed first announced that it would begin reducing or “tapering” its pandemic-era support.
The intervening period featured a spate of strong data, including a robust October jobs report and upward revisions to August and September’s gains. Inflation numbers that made clear price pressures were expanding provoked further discussion, as did additional evidence underscoring the strength of the US consumer.
“Part of the art of monetary policy is never becoming too dug in or too much in love with your prior positions. You have to adjust your stance as the facts on the ground change,” said David Wilcox, who is affiliated with the Peterson Institute for International Economics and Bloomberg Economics and used to work at the Fed. “The fact that they are doing so in a sensible manner in response to evolving evidence is exactly the way monetary policy is supposed to work.”
Economists expect the Fed to alter its language surrounding inflation and officially drop “transitory” from the statement. It will also publish new insights about the possible path forward for interest rates.
In September — the last time the so-called “dot-plot” of individual interest rate projections was updated — Fed officials were evenly split on the prospects of an interest rate increase next year.
Loretta Mester, president of the Cleveland Fed and a voting member on the policy-setting Federal Open Market Committee in 2022, told the Financial Times earlier this month that two interest rate increases may now be “appropriate” next year, a pace James Bullard of the St Louis Fed also backs.
Economists at Bank of America expect the dot plot to show two rate rises in 2022, and six across 2023 and 2024. Michael Feroli, chief US economist at JPMorgan, said the Fed could proceed at a faster clip, with one more rate increase tacked on to each year.
The Fed will also release individual projections for inflation, unemployment and economic growth. In September, the median forecast indicated that the core inflation measure would steady at 3.7 per cent this year before drifting lower to 2.3 per cent in 2022. It currently hovers at 4.2 per cent, and some economists expect the 2022 forecast to move closer to 3 per cent.
At 4.2 per cent, the unemployment rate has already dipped below the Fed’s median forecast of 4.8 per cent for 2021 and is inching closer to its 2022 threshold of 3.8 per cent. Aneta Markowska, an economist at Jefferies, expects it to be slashed further, with the jobless rate expected to fall to 3.5 per cent next year and 3.4 per cent the year after.
Despite the improved backdrop, many economists point to the uneven nature of the labour market recovery and the enduring risk posed by Covid — especially in light of the new variant — and advise the Fed to not stray too far from its patient approach.
“If we have a much smaller labour force and you lock that in, you are locking in a permanently smaller economy,” said William Spriggs, an economist at Howard University and AFL-CIO, whose name has been floated as a possible contender to fill an open seat on the Fed’s board of governors.
He also said raising interest rates would do little to resolve the inflation issue at hand.
“You cannot control a supply shock with a demand shock tool,” he added. “If your idea is that you are going to try to raise the cost of capital and induce greater savings and lower investment, that is not how you get out of this situation.”
Alan Detmeister, an economist at UBS and a former Fed staffer, added that premature interest rate increases could slow hiring and cloud the employment outlook.
Megan Greene, global chief economist at the Kroll Institute, is also among those to urge caution, not least because the effects of monetary policy changes take time to kick in.
“Central banks by definition need to be more like tankers instead of Lamborghinis,” she said. “This pivot by the Fed feels very Lamborghini-like.”