Finding out if the rebound in inflation would precipitate the removal of the lifeline that the Federal Reserve’s (Fed) monetary policy has provided during the pandemic during the pandemic was the main unknown surrounding the meeting that the central bank held this Tuesday and Wednesday in Washington. Previous messages from the institution about rising inflation as temporary and promises of caution until price stability is achieved and full employment is reached —the current unemployment rate is 5.8%, compared to 3.5% previously to the pandemic – they managed to partially alleviate the anxiety of the markets, but investors held their breath waiting to know the concrete decisions. A word, tapering (withdrawal of stimuli), was the key. But above all, a date was crucial: that of the disconnection calendar, knowing when the mechanical respirator will begin to be withdrawn from the economy. The forecasts were confirmed: there have been no definitive answers to the question, but there have been indications to orient itself in the medium term in a scenario of rampant recovery subjected to the pressure of inflation. As expected, the Fed has decided to keep interest rates intact, in the range between 0% and 0.25%, and does not plan to raise them until the end of 2023, a little earlier than expected (March 2024 ). The issuing bank has also raised the growth forecast for 2021 to 7% (6.5% in the March projection) and the inflation rate to 3.4%, one point above the last forecast (2, 4%).
However, the risk of more sustained inflation is a possibility that the Fed does not rule out. “As the reopening continues, changes in demand may be faster and larger than anticipated, and bottlenecks, contracting difficulties, and other conditioning factors may continue to limit the speed of supply adjustment, thus enabling inflation is higher and more persistent than we expect ”, Powell explained to reporters. “It is an absolutely extraordinary moment and we have no prior guidance or experience in such a situation. So we must be humble with our ability to interpret the data. ”
Wall Street awaited the Fed’s decision, adopted unanimously, with slight declines. The S&P index fell 0.3%, while the Dow Jones fell half a point and the Nasdaq technology, a negligible 0.1%. With equity markets fearful of a tapering abrupt, the story of the boom inflationary remained among analysts in the hours prior to the announcement of the conclusions. Despite the expectations of a complicated summer, overheated by consumer demand and still pending the evolution of the pandemic, most agreed when it came to conjecturing the decision of the 11 members of the FOMC (acronym in English for the Operations Committee of the Open Market), the department of the Fed responsible for deciding the US base interest rate eight times a year. “While inflation is unlikely to return to its below-average pre-pandemic pace (which would be a good thing), we see little reason to stray from the narrative of the shock transitory ”of inflation, argued Gilles Moëc, chief economist at AXA Investment Managers. “Core inflation will remain high, but we believe it is plausible that this source of inflationary drift will fade by the end of the summer; for the moment, the Fed can comfortably maintain its cautious stance. “
The publication, last week, of the CPI data sounded all the alarms. In year-on-year terms, prices shot up to 5%, the highest since September 2008 and well above the institution’s 2% target. Core inflation, which excludes food and energy, rose to 3.8%, from 1.3% a year in the Fed’s previous projection, and its highest level in 28 years. Bottlenecks in supply chains, the recovery of raw material prices, the reopening of the service sector and, above all, the unprecedented increase in the prices of used cars, generated the perfect inflationary storm.
One of the two pillars of the Fed’s lifeline is the purchase of assets, at a rate of 120,000 million a month since March 2020 (80,000 million in Treasury bonds and 40,000 in financial products linked to mortgage loans), and the previous meeting of the Fed had revealed some differences between the moderates and the hawks, in favor of already proposing the reduction of purchases. The other pillar has been to keep the price of money around 0% since the start of the pandemic. But even the Secretary of the Treasury, Janet Yellen, has pointed out that with the current rate of recovery the Fed may be forced to raise rates to avoid overheating. However, this Wednesday, a few hours before Powell’s appearance, the Minister of Economy insisted that the rise in prices is “temporary” and responds to “transitory” factors linked to the reactivation of the economy after more than a year pandemic.
“Wait and see”
Moëc believes that “maintaining a significantly high rate of asset purchases during the summer makes perfect sense in terms of risk management and there are three reasons to justify a situation of wait and see [esperar y ver] from the Fed: how markets can deal with what will be a tough summer for the Fed; to evaluate the strength of the recovery in consumption, and the evolution in the face of the pandemic, since the race between vaccination and variants is still underway ”.
The Fed also attributes a more optimistic outlook to the wide scope of vaccination, in a context in which “thanks to strong political support [el plan de rescate del presidente Joe Biden], the indicators of economic activity and employment have been strengthened “, says the Fed in the statement made public after the meeting. The sectors most affected by the pandemic, such as hotels and restaurants, “remain weak but have also shown signs of improvement.”
“We hope that the updates to the growth and unemployment forecasts will lead those in charge of the Fed to advance the average forecast of the first rate hike to 2023 (compared to March 2024). We also expect Fed leadership to actually address the asset purchase reduction plan. At the same time, we believe it will emphasize that the economic recovery still has a long way to go and that substantial progress has yet to be made, indicating that the reduction in purchases is unlikely to start until the second half of this year. year, “considered PIMCO’s Tiffany Wilding on the eve of the Fed meeting.” Powell could raise the idea of reducing bond purchases at the September meeting. Although our baseline scenario is still that the tapering is announced in December, we think that the Fed could reflect on the possibility of doing it in September in case inflation is more persistent than expected ”.