Breadth Thrusts & Bread Crusts: Following Up with the Fed

JC Parets
December 16, 2021

From the desk of Willie Delwiche.

This week's FOMC meeting has received more than its fair share of attention. 

Many are no doubt tired of hearing about it. Some might even mentally paraphrase Thomas Jefferson (in Lin-Manuel Miranda's Hamiliton): Can we get back to prices, please?

Yes, in just a moment.

Yesterday’s headlines announced that the "Fed doubles pace of tapering". Unless you are paying close attention, this probably seems like confusing doublespeak. My friend Joe Kalish (at NDR) put it more succinctly, "Fed Turning Off Liquidity Spigot Sooner." 

The Fed will end asset purchases early next year. Based on current expectations, this will be followed by three 25 basis-point interest rate hikes over the remainder of 2022. Powell was clear to emphasize that this pivot, while compelled by higher than expected inflation, has been made possible by improving labor market conditions and strength in the overall economy. That messaging probably helped stocks shake off early weakness yesterday and rally into the close.

Three observations:

  1. Slowly, then all at once. The pace at which Powell (and the rest of the Fed) have pivoted has left some heads spinning. Powell was explicit about the timing of the evolution of his thinking on inflation. It had to do more with data points than political developments. The pace seemed dramatic because it was like a log function observed on a linear scale (think about passing a car on the freeway). Nothing happens. And then, it happens all at once. An ability to adapt to new realities is important, and risks increase the longer one waits to take action.
  2. Follow the leader. If reality matches expectations (a big "If", I know), then the Fed will be raising rates at some point next year. It's important to recognize that this cycle will be different from previous tightening cycles in a very significant way. In the past, the US has led and other central banks have followed. In this cycle, other central banks have already started to raise rates (the Bank of England did so today). By the time the Fed raises rates next year, it is likely that half of all major global central banks will be raising rates. The benign historic effects of initial rate hikes by the Fed may be offset by it being a laggard on the global stage.
  3. Conflation on inflation. Powell and the Fed have whiffed on inflation in a pretty significant way (see Tuesday's Perspectives piece for more details). Powell's comments yesterday continue to suggest that inflation is largely a supply chain-related development in the wake of last year's shutdown. Inflation was heating up prior to COVID and it is now a global phenomenon. Until the Fed updates its inflation narrative to reflect reality, the risk of policy error is likely elevated. Simply put, the Fed spent most of 2021 revising its inflation expectations higher, and is set up to do the same in 2022.

 

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