With uncomfortably high inflation and the COVID-19 Delta variant sparking economic concerns, a divided Federal Reserve will meet this week to discuss when and how it should reverse its ultra-low interest rate policies.
For now, the U.S. economy is growing rapidly in the wake of the pandemic recession, and the pace of hiring is healthy, which is why Fed policymakers are likely to be moving closer to next action. . In particular, officials are expected to discuss the timing and mechanisms for slowing down their purchases of $ 120 billion per month bonds – a pandemic-era policy that aims to keep long-term lending rates low to stimulate debt. borrowing and spending.
This week’s meeting takes place against the backdrop of a risky political bet by Fed Chairman Jerome Powell. Mr Powell is betting that the central bank can devise an extremely delicate task: to keep the Fed’s short-term benchmark rate close to zero, where it has been since March 2020, until the labor market is fully healed, without fueling a sustained fight against high inflation.
Still, the stakes around this bet are rising, with consumer prices jumping 5.4% in June from a year ago, the biggest increase in 13 years. Last month’s surge marked a fourth consecutive month of surprisingly large price increases, which has heightened fears that ever higher inflation will erode the value of recent wage increases and undermine the economic recovery.
The main concern is that the Fed will eventually react too late and too aggressively to high inflation by raising interest rates quickly and possibly causing another recession. Last week, Republicans in Congress littered Mr. Powell with questions about inflation, for which they largely blamed President Joe Biden’s $ 1.9 trillion stimulus package, which was enacted in March.
In his testimony, Mr. Powell largely maintained his view that higher inflation will be temporary. His reasoning is that recent high price increases – for things like new and used cars, hotel rooms, and airline tickets – have been mostly due to supply shortages linked to the rapid reopening. economy. But he also said more explicitly than before that the Fed would not hesitate to hike rates if it decided inflation got out of hand.
After a period of broad agreement during the pandemic crisis, Fed policymakers seem divided on when to start cutting – or âcutting,â in Fed parlance – its monthly bond purchases. Several regional Fed bank presidents support the upcoming cut, including James Bullard of the St. Louis Fed, Patrick Harker of the Philadelphia Fed and Robert Kaplan of the Dallas Fed.
Mr Powell said the central bank wanted to see “further substantial progress” towards its goals of maximum employment and price stability before considering cutting bond purchases. To compensate for years of inflation remaining below 2%, Mr Powell said, the Fed wants inflation to moderately exceed its average inflation target of 2% and shows signs of staying above for a period of time. indeterminate. In recent months, as consumer demand has outstripped the supply of goods and services in some industries, inflation has exceeded 2%.
Mr. Powell suggested during his testimony to Congress last week that the economy was “still a long way off” from making such progress. When the Fed issues a policy statement on Wednesday and Mr. Powell holds a press conference, any signal that such progress is near could mean the Fed is getting closer to cutting its bond purchases.
Nathan Sheets, chief economist at PGIM Fixed Income and former director of international finance at the Fed, said the division of the Fed reflects two very different ways of looking at the economy. Officials who support an early cut are likely focused on current levels of high inflation and the fact that the economy has almost returned to its pre-pandemic size.
Hiring is robust and is mostly held back by a shortage of workers rather than a lack of demand for them, Mr. Sheets said. According to this view, there is little the Fed can do about the labor supply.
âThe economy is, at the end of the day, a lot better than it was a year ago,â Mr. Sheets said. “It’s getting harder and harder for the Fed to explain why it needs to keep buying $ 120 billion in assets per month.”
Yet Mr Powell and the rest of the Fed executives – including Richard Clarida, vice chairman of the board of the Fed, and John Williams, chairman of the Federal Reserve Bank of New York – will likely stick to it. a slow approach to withdrawing economic support. , said Mr. Sheets.
It is not yet clear how the highly contagious and rapidly spreading delta variant of the coronavirus could affect the US or global economies, Mr Sheets said, or how the job market will fare in the months to come. Hiring could accelerate in September as schools reopen, more parents can take jobs, and expanded unemployment assistance programs expire.
“There is no reason for us to be in a hurry here,” said Mr. Sheets, summing up the likely point of view of management. The bond market is signaling much less concern about future inflation, as the 10-year Treasury bond yield has fallen almost half a percentage point since the spring, to around 1.28%.
It also gives the Fed more time to consider its options, Mr. Sheets said.
Mr Powell said the Fed would communicate its intention to cut “well in advance” of doing so.
David Mericle, an economist at Goldman Sachs, said based on historical practice, that would mean the central bank will likely signal its intentions about two meetings before announcing a move. As a result, Mr. Mericle predicts that the Fed will provide its first clear clue on tapering at its September meeting, followed by another signal in November before announcing actual tapering in December.
This story was reported by The Associated Press.