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Crossmark Global Investments CIO Bob Doll discusses Fed Chairman Jerome Powell’s press conference concerns about inflation and its outlook for markets against a backdrop of fiscal policy.
Throughout the year, the Federal Reserve’s message on inflation has been consistent: This year’s surge is transitory, and inflation will soon return to close to the central bank’s 2% target.
Still, take a closer look, and it’s clear that officials are becoming less optimistic, which explains the growing rush to start raising interest rates.
Last September, long before supply bottlenecks appeared, the median forecast by Fed officials was core inflation (which excludes food and energy) in 2022 of 1.8 %. Every few months since then, they’ve pushed that up, and in the forecast released on Wednesday, they see core inflation next year at 2.3%.
MOM OF THE WHITE HOUSE ON POWELL FED RENEWAL
While the forecast for the current year is greatly influenced by temporary factors such as higher oil prices, the forecast for next year reflects where inflation is expected to set in once the temporary factors settle. ‘will attenuate. The message from the Fed’s latest projections is that the “transitional” lasts an awfully long time. Indeed, the 2.3% projection for next year is the highest core inflation forecast for next year since the projections were first released in 2007, according to Derek Tang of Monetary Policy Analytics.
This could explain why the Fed is stepping up its interest rate hike plans. The Fed is now buying $ 120 billion a month in bonds and wants it to drop to zero before it starts raising rates. On Wednesday, the Fed said it would likely start cutting those bond purchases in November, meaning the process would be complete by mid-2022, paving the way for a rate hike. Half of Fed officials believe rates will start rising by the end of next year. Last March, a majority of officials didn’t see this happen until 2024.
Simona Mocuta, Senior Economist at State Street Global Advisors, and Sandy Villere, Portfolio Manager at Villere & Co., discuss the state of the market after Jerome Powell’s speech.
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What changed? It is not because the economic outlook is stronger. In fact, officials are now seeing slower growth and higher unemployment than in March. President Jerome Powell explained that some officials simply wanted more confidence in the expected recovery to materialize. But inflation risks clearly play a role.
An inflation rate of 2.3% is not a big deal. Indeed, this would conform quite closely to the Fed’s new target of letting inflation exceed 2% for a while to compensate for the many years it has fallen below 2%. Yet if officials are wrong, it is likely that they turned out to be too low in their forecast. With unemployment expected to fall to 3.8% by next year and 3.5% by 2023, the economy will operate with little or no spare capacity, conditions that typically cause an increase in inflation.
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Fed officials believe inflation risks are on the rise; a majority said so on Wednesday. Six of 18 Federal Open Market Committee participants believe core inflation will be 2.5% or more next year.
If the Fed is more concerned about inflation, investors are not. Long-term bond yields edged down on Wednesday and implied future inflation rates on bonds haven’t changed much since May. The market may have more faith in the Fed’s “transitional” story than in the Fed itself.
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