WASHINGTON (BLOOMBERG) – Team Transitory is throwing in the towel.
In a clear sign that the United States Federal Reserve is shifting to tighter monetary policy, Fed chief Jerome Powell – who has spent months arguing that the coronavirus pandemic surge in inflation was largely due to transitory forces – told Congress on Tuesday (Nov 30) that it is “probably a good time to retire that word”.
Mr Powell, tapped last week for another four-year term, still thinks inflation will ebb next year. But in testimony before the Senate Banking Committee, he acknowledged that it is proving more powerful and persistent than expected, and said the Fed will consider ending its asset purchases earlier than planned.
“It looks like the Fed wants to create some space to give them the option to raise rates well before the end of next year if they feel they need to,” said Fitch Ratings chief economist Brian Coulton.
Tightening credit before the jobs market has returned to the halcyon days that prevailed before Covid-19, when black unemployment was at record lows and labour force participation was elevated, could invite criticism that the Fed is stepping away from the new monetary policy framework it adopted last year. That was designed to ensure jobs gains that were broad-based and inclusive.
For markets, what Mr Powell had to say about the two T-words – transitory and tapering – pointed in the same direction: policymakers are preparing the ground to raise interest rates much earlier than they had anticipated just a few months ago, when the emphasis was on waiting until the economy was back to full employment.
How soon is that? After Mr Powell’s remarks, money markets estimated a 50/50 chance that the Fed will hike as early as May, and they are pricing in around 60 basis points of increases by the end of next year. That is more than they had anticipated at the start of the day – but less than a week ago, before the world heard much about the new Omicron strain of Covid-19, which poses fresh dangers to the economic outlook.
Not Baked In
Mr Powell cited that risk, and said “it’s not really baked into our forecasts” but did not dwell on it much. He was more concerned with spelling out the Fed’s latest thinking on prices and employment.
Since the reference to “transitory” inflation first appeared in the Fed’s policy statement in April, it has been ever-present – and at the centre of a fierce debate. Critics like former treasury secretary Larry Summers accused Mr Powell and his team of downplaying the danger of a sustained bout of price pressures.
To hear Mr Powell tell it, the problem with the “transitory” label was partly about messaging. While many in the markets saw it as suggesting that the Fed expected price pressures to be short-lived, Mr Powell said policymakers intended it to mean that inflation would not become entrenched.
“The word ‘transitory’ has different meanings to different people,” he said. “We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation.”
‘What We Missed’
But it is about more than just messaging. The Fed misjudged the vigour of the inflationary impulses hitting the economy as it simultaneously opened up more fully after last year’s virtual shutdown while still dealing with the reality of an ongoing pandemic.
The personal consumption expenditures price gauge, which the Fed uses for its 2 per cent inflation target, rose 5 per cent in October from a year earlier.
“What we missed about inflation is that we didn’t predict the supply side problems,” Mr Powell said.
Those issues, from a shortage of microchips to a shipping squeeze, have ramped up costs for business and forced consumers to pay more for products they want that are in limited supply.
Mr Powell said the Fed had also been caught out by the performance of the job market. Officials had expected Americans to flock back into the labour force after schools reopened in autumn and extended unemployment benefits had expired. That has not occurred – at least so far.
The result has been a near record level of unfilled job openings, and bigger wage increases. US employment costs rose at the fastest pace on record in the third quarter against a backdrop of widespread labour shortages.
The Fed is currently scheduled to complete its bond-purchase programme in the middle of next year under a plan announced at the start of last month. Policymakers next meet on Dec 14-15, when they could decide to speed up that timetable.
“This is a very abrupt pivot,” said Evercore ISI vice-chairman Krishna Guha. “The likelihood that the Fed goes on to make a step-change in its rate plans is much higher than usual.”
Raising interest rates, though, would be far more consequential than ending bond buys. It would constitute a tightening of policy and an overt attempt to rein in the demand that has helped the US economy climb out of its Covid-19 slump faster than most global peers.
Under the new monetary policy framework it adopted last year, the Fed said it would countenance inflation above its 2 per cent target for a while to make up for past shortfalls, while also seeking to foster job gains that were broad-based and inclusive.
But Mr Powell said it might take some time to return to the stellar jobs market that was in place before Covid-19, and that inflation would have to be brought under control in order to do it.
“To get back to the great labour market we had before the pandemic we’re going to need a long expansion,” he said. “To get that we’re going to need price stability.”
“The biggest change I saw in Powell was the lowering of the ceiling of the labour market,” said LH Meyer Monetary Policy Analytics economist Derek Tang. “Once that happens, the maximum employment door is open, so they can start talking about lift-off.”
Join ST’s Telegram channel here and get the latest breaking news delivered to you.
Source: Read Full Article