Is the Fed clear about inflation?
Powell pointed out that the path to price stability involves a prolonged period of below-trend growth and an increase in the unemployment rate. The analysis by Jeffrey Cleveland, Chief Economist of Payden & Rygel
At the FOMC meeting in September, Fed Chairman Jerome Powell reiterated the Jackson Hole message, underlining the Fed's willingness to bring inflation back to 2% even at the cost of a recession.
As Alan Blinder, former vice president of the Federal Reserve once said, "there is price stability when you stop talking about inflation." Inflation, on the other hand, animated most of the debates before, during and after the last FOMC meeting and it is likely that market participants will not talk about anything else in the near future.
Since inflation is on everyone's lips, central bankers fear it could influence all other economic decisions, from wage demands, to price level setting, to investment. And, as the next few months are set to be filled with the inflation debate, their fears will only increase.
How will the Fed ensure price stability? “We will continue to do so until the job is finished”: Powell's response during the post-meeting press conference is a clear reference, in homage to Paul Volcker's memoir, to rate hikes. Considering the latest 75 basis point hike in September, the Fed has increased the benchmark rate by 300 basis points overall this year.
For this year, policymakers estimate an overnight rate of 4.25-4.50%. If the Fed sticks to this forecast (likely in our view), 2022 will be characterized by the strongest annual percentage point increase since 1981.
Policymakers also expect a 4.50-4.75% fund rate at the end of 2023, which means the Fed intends to hit its "extreme" rate and keep rates high for longer than most. of market participants expect (the Fed Funds futures market expects cuts in the third quarter of 2023). Powell even specified that real (ie inflation-adjusted) interest rates should be in positive territory "along the yield curve" before the Fed's work is completed.
Many are wondering how rate hikes will affect inflation in the short term. Powell admitted underlying inflation is likely to remain persistent next year due to rising housing prices. Perhaps, therefore, as a reporter speculated during the press conference, a correction in the housing market could help the Fed reach its goals more quickly.
Perhaps central bankers are hoping that bold talk of inflation will dissuade public opinion from discussing it, keeping expectations anchored and inflation in check.
In practice, Powell pointed out that the path to price stability implies “a prolonged period of below-trend growth” and “an increase in the unemployment rate” up to 4.4% in 2023, according to the policymakers' estimate.
It therefore appears that the FOMC expects inflation to be "crushed" by a recession, which has historically occurred whenever the three-month average unemployment rate has risen by just 0.5%. The unemployment rate is 3.7%, up from the low of the cycle of 3.5%. Will a further increase to 4.4% be enough?
Despite the sharp rise in interest rates from year to year, the US economy remains solid. Powell sees a labor market that is still unbalanced and extremely rigid, with the supply of labor varying little compared to the beginning of the year and with the risk of a spike in wages and persistent underlying inflation also into the next year. .
Powell finally cited the 3-, 6-, and 12-month annualized rates of change of the Fed's preferred underlying inflation indicator, the core PCE, saying that the "rate of increase above 4.5% in all periods is far too much. high ”for price stability. The risk, if anything, is that the Fed has to do more to ensure price stability – a sobering idea given this year's rate changes.
In conclusion, the Fed will not only continue to raise and keep rates high throughout 2023, but it will do so even if the unemployment rate rises.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/inflazione-fed-powell/ on Sat, 24 Sep 2022 06:14:00 +0000.