Is The Fed’s Inflation Hourglass Running Out of Sand?

By TradeSmith Editorial Staff

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Every time the mainstream press reports on Jerome Powell and the Federal Reserve, they should play the ticking clock music from the famous Kiefer Sutherland show “24.”

Because time is running out for the central bank to confront the red-hot inflation that has invaded the U.S. economy. For years, the Federal Reserve provided billions in quantitative easing, yet regularly stated that the economy wasn’t keeping in line with its 2% annual inflation target.

Fast forward to 18 months since the COVID-19 market crash and the bank’s decision to inject trillions into the markets, and inflation is running at its hottest pace in decades. The Fed faces unfamiliar territory to address weak hiring patterns, broken supply chains, and strong consumer purchasing ahead of the holiday season.

Next week, the central bank will meet for two days to discuss tapering its massive balance sheet and the timing of its next interest rate hike. So today, I want to offer a preview of what to expect.

Inflation Hits a Hair-Raising Level

It might be Halloween, but the scariest thing this October is inflation. Ongoing supply chain challenges have created some product shortages ahead of the holiday season. But Americans have still experienced higher household income levels thanks to rising wage pressures and pandemic aid from the government. As a result, consumption isn’t slowing down.

The Personal Consumption Expenditures (PCE) Price Index — an inflation metric that tracks Americans’ purchases — hit a 30-year high in August (the latest data point). We continue to hear members of the Federal Reserve suggest that inflation will ease in 2022 without any need to hike interest rates in the months ahead.

But a quick scan of the headlines dating back to March suggests that the central bank has been well behind the curve in understanding the longevity of inflation today.

  • April 12, Forbes: Here’s Why the White House Isn’t Worried About Inflation

In this article, the author highlights an April “60 Minutes” interview with Fed Chair Powell. During this interview, Powell dismissed inflation as the biggest risk to the economy, and instead raised concerns around cybersecurity and the spread of COVID-19. However, according to an April survey by Bank of America, 37% of portfolio managers worried that inflation was the largest threat.

But, as we saw in the following months, news reports started to display that the central bank was increasingly worried about inflation.

  • May 14, CNBC Television: White House Press Secretary Jen Psaki and [Council of Economic Advisers] CEA Chair Cecilia Rouse hold a briefing

This briefing offered a surprising revelation about the experts’ expectation around inflation.

When asked about the jump in inflation, Rouse responded: “So, we hadn’t forecasted that. The forecasters hadn’t expected that.” Rouse also noted that the Federal Reserve was “a bit surprised by the jump” before predicting “some choppiness” for the months ahead.

  • June 30, The New York Times: Fed Unity Cracks as Inflation Rises and Officials Debate Future

In this article, the author writes: “The Fed’s top officials, including Chair Jerome H. Powell, acknowledge that a lasting period of uncomfortably high inflation is a possibility. But they have said it is more likely that recent price increases, which have come as the economy reopens from its coronavirus slumber, will fade.”

  • July 28, CNN: All Bets Are Off if the Fed and White House Are Wrong About Inflation

The opening line: “The White House and the Federal Reserve broadly agree: Inflation isn’t here to stay.”

  •  Aug. 27, The Wall Street Journal: White House More Than Doubles Its Inflation Forecast in New Update

The opening line: “Administration expects consumer prices to rise 4.8% in the fourth quarter from a year earlier, lifts projections for growth this year.” That is quite a development compared to expectations from just a few months earlier.

  • Sept. 22, NPR: The Fed Says Inflation Is Hotter Than Expected

The opening line: “The Federal Reserve says inflation will be somewhat higher than expected this year, but the central bank still believes it will cool off next year.”

  • Oct. 15, The Washington Post: Uncomfortable Inflation Is Here, and it’s Changing the Economy

The opening line: “American families and businesses are changing their habits as they increasingly believe high prices are here to stay.”

It appears that Americans are quickly understanding that “transitory” inflation may be here much longer than expected and predicted by the so-called experts.

So, how will the narrative around inflation shift in November? We’re about to find out.

Next Week’s Meeting

The Fed will kick off its two-day meeting on Tuesday and announce the timing of tapering (and potentially interest rates) on Wednesday. However, it’s worth noting that the central bank is unlikely to take any action on interest rates.

According to CME FedWatch, a site that tracks the likelihood of rate hikes based on moves in the market, investors expect that the central bank will hold off on raising interest rates until June 2022. However, the market has priced in a 65.6% probability of a rate hike on June 15, 2022.

But many Fed members have signaled that they do not want a rate hike until later in the year.

The challenge, unfortunately, is that the Fed likely cannot allow inflation to run this hot for too long. But before it takes action, it also must taper its balance sheet and take its foot off the gas for pandemic-era stimulus. Since this crisis started, the central bank has been pumping $120 billion per month into purchasing bond and mortgage-backed securities. But the weak employment reports over the last few months and exodus of workers from the labor force draws questions about whether the Fed will stop trying to maximize employment to cull inflation.

Inflationary pressures didn’t come out of nowhere, but this combination of economic forces doesn’t appear to have much precedent. Some economists and pundits have said that the current annual inflation conditions resemble those of the 1970s.

The temptation to compare historical periods to unprecedented ones is what got the White House and the Fed in trouble months ago. We won’t be making the same mistake.