EDITOR'S NOTE: Newly re-upped Fed Chair Jerome Powell hasn’t just done a 180 on inflation, he’s done it at warp speed. Wolf Street reports that since Powell has retired his “transitory” view on inflation, he’s now going full speed in the other direction, promising swift and aggressive action that may be as dangerous to the economy as his earlier downplaying was. He recently said, “There is a real risk now that inflation may be more persistent. The risk of higher inflation becoming entrenched has certainly increased.” QE is going to come fast, and now there will be three interest rate hikes in 2022. Many have noted that Powell is still “behind the curve” on inflation, but he now seems to be on it. However, after ignoring it for so long, is jamming on the economic emergency brake the best option? Right now, it seems like the only one Powell is going to try.
Inflation now a “big threat.” After downplaying inflation all year, the Fed is starting to get serious.
“There is a real risk now that inflation may be more persistent,” Fed Chair Jerome Powell said today at the press conference, after downplaying it all year. “The risk of higher inflation becoming entrenched has certainly increased,” he said. “Part of the reason behind our move today is to put ourselves into the position to be able to deal with that risk. And I think we are in a position to deal with that risk.”
The most important thing to come out of the Fed meeting and Powell’s press conference afterwards is that everything is moving much faster than last time, that it’s moving much faster than the Fed said it would move just a few months ago: Inflation, wage increases, ending QE, hiking rates, and shrinking the balance sheet.
Balance sheet reduction now on the table.
“We had our first discussion about the balance sheet,” Powell said. He mentioned this several times in the press conference to make sure everyone got it: The balance sheet run-off is now actively being discussed.
No decision has been made yet whether to start the run-off before the initial rate hike or sometime after “liftoff” – as last time. “But those are exactly the decisions we’ll be turning to in coming meetings,” he said.
Last time, the Fed began tapering its asset purchases in early 2014 and ended QE in December that year. Then the balance sheet remained flat, and interest rates remained near 0% till December 2015, when the Fed hiked its rate by 25 basis points. In December 2016, the Fed hiked for the second time. In 2017, it hiked three times. At the end of 2017, it started its balance sheet runoff in baby steps that didn’t reach full speed ($50 billion a month) until the end of 2018. From the beginning of the taper to full-speed balance-sheet runoff took five years.
Powell said the recovery back then was much weaker, inflation was low, and unemployment was much higher than today, and they could afford to move slowly in removing accommodation and then tightening.
Given how fast the economy has been moving in this recovery, with “growth above potential,” the unemployment rate falling rapidly, and “inflation well above target” – “and this is something we have to take into account,” he said – “there wouldn’t be the need for that kind of long delay” with rate hikes and balance sheet reduction.
End of QE moved to mid-March, from June. Door opened for even quicker end.
The decision to double the speed of the taper, from a $15-billion-a-month reduction of QE to a $30-billion-a-month reduction, was made informally weeks ago, before he’d been re-nominated, Powell said. And that’s why Fed governors had been giving speeches about speeding up the end of QE.
This was driven by the spike of inflation readings after Labor Day as price increases were suddenly spreading “to a broader range of goods and services,” Powell said.
Last time the taper took a year. At the November meeting, the Fed said it would cut its monthly QE by $15 billion a month, and end QE entirely in June – so eight months.
Today the Fed announced that it would double the speed of the taper to $30 billion a month going forward, and would end QE entirely in mid-March– so five months total.
But the Fed also said that “it is prepared to adjust the pace of purchases if warranted by the economic outlook,” which is precisely what it had said at its November meeting. There are only two meetings left before the end of the taper. And the Fed opened the door for ending QE even sooner than mid-March.
“A quicker conclusion of our asset purchases will better position policy to address the full range of plausible economic outcomes,” Powell said in the press conference.
The Fed will end QE entirely before raising short-term rates, Powell reiterated today. But this time around, the process is going to happen much faster.
Rate hikes moved forward, now three in 2022.
In its post-meeting projection materials, the median projection amounted to three rate hikes in 2022, bringing the upper end of the target range to 1.0% by the end of 2022. At the meeting a year ago, the FOMC members projected no rate hikes in 2022. At this pace, the number of rate hikes in 2022 might well increase further.
Inflation is now a “big threat.”
High inflation “is one of the two big threats, the other being the pandemic itself, to getting back to maximum employment,” Powell said.
“With inflation as high as it is, we’ve got to make policy in real time, and cannot wait till labor participation might rise,” he said.
“One of the big threats to getting back to maximum employment is actually high inflation,” Powell said. “To get back to where we were is going to take some time, and what we need is another long expansion,” he said, such as the last expansion “which was the longest in our recorded history,” he said. “That’s what it would take to get back to the kind of labor market we’d like to see, and to make that happen we need to make sure we maintain price stability.”
Isn’t the Fed “behind the curve?” he was asked.
“I wouldn’t look at it that we’re behind the curve, but I would look at it that we’re actually in a position now to take the steps we’ll need to take in a thoughtful manner to address all of the issues, including that of too high inflation,” Powell said.
And amid heavy political pressure, he admitted to some of the horrible costs of inflation that many people have to deal with: “We understand that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials like food, housing, and transportation,” Powell said.
Originally posted on Wolf Street.