Investors will scour the Federal Reserve’s political statement and economic outlook on Wednesday for evidence that the latest data is surprising – inclusive faster than expected inflation and slower employment growth – upset the central bank’s plans for its cheap money policy.
It is unlikely that policymakers will not make major changes at a time when interest rates will stay close to zero for the years to come, but a series of tiny tweaks to their monetary policy messages and new economic outlook could make this week’s session a watchable one an important moment for the markets.
The central bank will make new economic forecasts from theirs 18 officials for the first time since March, when the Fed hadn’t forecast a rate hike until at least 2024. Policy makers could plan an earlier move and move the initial rate hike forward by 2023.
Markets will also be on the lookout for subtle hints of the upcoming $ 120 billion monthly bond purchases by the Fed, which have kept many types of credit cheap and soared the prices of stocks and other assets. Several Fed officials have announced that they will soon discuss plans to slow their bond purchases, although economists expect it will be months before they send a clear signal to investors as to when the “taper” will begin.
The Fed will publish the monetary policy announcement of its two-day meeting at 2 p.m., followed by a press conference with Chairman Jerome H. Powell.
The central bank may want to use the meeting and Mr Powell’s remarks to “prepare, or we will deny it completely until we realize, ‘Ouch, the Fed is stepping back,” “said Priya Misra, head of global interest rate strategy at TD Securities. The point may be to say, “You don’t run to the exits, but at least you plan the escape route.”
As the Fed shows a way forward for policy, the Fed must weigh signs of economic recovery – rapid gains as demand rebounds faster than supply, and numerous job openings – against the realities that lie ahead for millions of people return to work. The shortage is likely due to a cocktail of factors as older workers retire, potential immigrants stay in their home countries, and viral fears, childcare issues, and expanded government benefits all work together to keep potential employees at home.
Many workers may simply need time to familiarize themselves with new and suitable jobs, and the Fed is likely to signal that it plans to continue providing political support in this regard. Here’s what else to look for.
The Fed is working with higher inflation.
The Fed is aiming for inflation that will be “moderately above 2 percent for a while”, to eventually reach an average of 2 percent. In its policy statement it has long been said that the price gains are “permanently below this longer-term target”. After several months of inflation numbers above 2%, it may be time to update this language to reflect recent price spikes.
But the Fed, like many financial economists, assumes that this pop will prove temporary. The 5 percent rise in the consumer price index is partly due to the fact that prices fell during the intense lockdowns last year, which makes current year-on-year comparisons seem artificially elevated. Without this so-called base effect, the increase would have been around 3.4 percent.
Obviously that’s still too high. The rest of the spike came as wages rose and demand recovered faster than global supply chains, causing bottlenecks in computer chips and causing shipping problems. While base effects should subside quickly, it is unclear how quickly delivery bottlenecks will be resolved. The semiconductor problem, for example, could clear up in the coming months, but some importers believe that a shortage of shipping containers could last at least into next year, potentially increasing prices for some products.
This uncertainty was compounded by the fact that the rise in inflation came faster than officials expected. If the Fed’s preferred inflation index were completely still at its April levels, inflation would rise 2 percent this year. Instead, prices have continued to rise, and most likely already have on track to exceed the Fed’s 2.4 percent forecast for 2021. That means officials will have to revise their estimates upwards when they release new economic forecasts. The big questions are to what extent and whether the revisions will bleed into the next year.
Mr Powell will likely claim the recent surge is temporary, but he will likely have to take the risk that inflation expectations and wages will rise faster and hold on to faster gains. He has previously said that this is a possibility, but an unlikely outcome.
“It’s perhaps a little less flashy than at the April press conference,” said Michael Feroli, US chief economist at JP Morgan.
Political plans may require some adjustments.
Goldman Sachs economists don’t expect the Fed to announce, with a formal announcement in December and an actual start of tapering early next year, that it will slow its bond purchases until August or September.
Even then, it will be a long time before the Fed really cuts its monetary support. The Fed has suggested that it will signal first that it is thinking of slowing bond purchases, then actually reducing it, and only then raising interest rates. Goldman strategists estimate that “even if the labor market recovery accelerates rapidly from here,” the first rate hike would likely be “at least” 15 months away.
Mr Powell could say or suggest during his press conference that the Federal Reserve’s Policy-making Open Markets Committee is taking the first small step towards this process – what has been called “talk about talking about tapering.”
Officials could also start creating a schedule for pay increases. The so-called the Fed Scatter plot of the interest rate forecasts showed no rate hikes in March until 2023, the last year of the forecast. Many economists expect it to show a rate hike after revisions in 2023.
Work is lagging behind.
But the Fed’s outlook is likely to remain patient – suggesting years of low interest rates – as the labor market still has plenty of room to recover. over seven million fewer people registered as employed in May than in February 2020.
While recent employment gains have been robust by normal standards, they have been slow compared to the remaining gap in the labor market. After rising a solid 785,000 jobs in March, hiring has slowed to an average of 418,500 jobs over the past two months.
The Fed has two goals – stable inflation and maximum employment – and the recent slowdown in hiring means it may take a little longer to hit the second goal.
“The bottom line is that I’d like to see more progress than we are now,” said Loretta Mester, president of the Federal Reserve Bank of Cleveland, shortly after the May job report was posted on CNBC. “We deliberately want to be patient here, because that was a huge shock for the economy.”
Because of this, economists are on the lookout for tweaks this week – but not much of a move away from the Fed’s supportive stance.