Fed faces a contest between supply, demand and “patience”

The authorities of the Federal Reserve (Fed) face a test of their ability to ignore high inflation and are now navigating their own feelings of patience and risk, amid a US economy contained by problems in supply chains, slow hiring and strong consumer demand.

The combination of supply bottlenecks and rising household incomes, driven by government aid related to the pandemic, made the price index of personal consumption expenditures, a key measure of inflation, will reach its highest level in 30 years in year-on-year terms in August.

Policy makers continue to hope that the rate of price increases will slow without the Fed pushing the process by raising interest rates earlier and more than expected.

However, that judgment now depends on a career.

Will disruptions, such as the 100-ship bottleneck at California’s Los Angeles-Long Beach port complex, go away before homes run out of excess savings estimated at $ 2 trillion accumulated during the pandemic? Will that happen before recent price hikes show up in public expectations about future inflation?

The latter may already be beginning. An index of inflation expectations from the Fed, followed by senior officials from the US central bank, has risen for five consecutive quarters, something unprecedented.

At 2.06%, it is above the Fed’s 2% target, and is likely to rise. Consumer expectations have also grown. The Conference Board reported Tuesday that its October one-year consumer inflation expectations survey reached 7%, the highest since July 2008.

Bond markets, which also anticipate higher inflation, are pricing in an earlier start and a more aggressive pace of the Fed’s interest rate hikes.

“At first, it was easy to be patient. The fundamental dilemma we face is this: Demand, augmented by unprecedented fiscal stimulus, has outpaced supply that suffers temporary interruptions“Fed Governor Randal Quarles said last week.

However, the “fundamental capacityThe economy is still intact, and Fed officials want to keep interest rates low for as long as possible to let jobs rise.

“Restricting demand now, to bring it into line with a temporarily interrupted supply, would be premature“Quarles noted, but”my attention begins to focus more fully on whether inflation starts to decline”.

“Tension” in the air

The Fed holds a monetary policy meeting next week and is expected to announce its plans to phase out its $ 120 billion in monthly asset purchases by mid-2022.

Between now and next summer, the trajectory of inflation, inflation expectations and job growth will determine whether the central bank accelerates the date to raise its target interest rate from the current level close to zero.

A year ago, before the arrival of vaccines COVID-19 And at the start of a devastating wave of infections, the prospect of rising credit costs seemed distant. Only four officials of the Fed’s monetary policy anticipated the need to raise rates before 2024.

Now, half of the 18 authorities are forecasting a hike in 2022, a move that would come as the Joe Biden administration is funding new spending and likely before employment has returned to pre-pandemic levels. This could complicate the Democrats’ efforts to maintain control of Congress in the November 8, 2022 election.

The president of the FedJerome Powell has pointed out the emerging “tension”Between the central bank’s employment and inflation targets.

When asked in April about when he would be concerned that the inflation expectation “transitory”Of the central bank could be wrong, the vice president of the Fed, Richard Clarida, cited “The end of the year”. The governor of the Fed, Chris Waller, set the same deadline last week.

“It seems that we are at a turning point and the question is if some of the old problems come back to haunt us“Said Peter Ireland, professor of economics at Boston College.

It is an option that the officials of the Fed they hoped to sidestep with a new policy framework built to capture job gains that they believe were lost in previous business cycles when interest rates were raised too early.

That framework depends on inflation, labor markets, and other parts of the economy behaving as before. At least for now, the pandemic has cast doubt on this premise.

It’s not just things like the global shortage of computer chips, capacity constraints in warehouse construction, or other supply problems that have put the Federal Reserve’s narrative of “transitory” inflation to the test. Household behavior and the actions of elected officials also cloud the horizon.