Federal Reserve policymakers seem to be at something of a disconnect with financial markets regarding the risks posed by inflation.
Yields on Treasuries have been steadily rising and are feeding through to mortgage rates, but Fed officials still see more disinflationary risks, at least according to the minutes of January’s Federal Open Market Committee meeting released last week.
“Participants generally viewed the risks to the outlook for inflation as having become more balanced than was the case over most of 2020, although most still viewed the risks as weighted to the downside,” the minutes of the January 26-27 meeting said.
If anything, policymakers expected rapid price increases to be spotty due to supply constraints from the COVID-19 pandemic. They are not worried about that.
“Many participants stressed the importance of distinguishing between such one-time changes in relative prices and changes in the underlying trend for inflation, noting that changes in relative prices could temporarily raise measured inflation but would be unlikely to have a lasting effect.”
The FOMC meeting was more than three weeks ago, and perhaps the thoughts of committee members on this issue have evolved. Even then, however, policymakers were counting on a fiscal stimulus of $1.9 trillion, and the prospect did not seem to worry them.
Disconnect Setting Up Between ECB and Fed Policies
There is also the beginning of a disconnect between the Fed and monetary policy in the eurozone. The minutes of the January 20-21 meeting of the European Central Bank governing council showed policymakers sanguine about inflation, noting that it probably turned positive in January after months of decline while remaining subdued.
But the minutes also contained a cautionary proviso:
“It was emphasized that the medium-term outlook for inflation was surrounded by a high level of uncertainty, given the unprecedented pandemic situation and long-standing questions about changes in the underlying determinants of inflation.”
As data released well after the ECB meeting indicated, eurozone inflation in January came roaring back, with a 0.9% jump in prices compared with consensus expectations of just 0.5%. Much of the gain was attributed to onetime factors, and economists expect that rate of increase to slow in coming months.
The governing council thought in January that inflation dynamics might change with a rebound in activity in the second half of the year, and “the point was made” that a temporary boost should not be mistaken for a sustained increase. But the council is clearly alert to risks and the surprise surge in January will make hawks like Bundesbank President Jens Weidmann even more cautious.
On the other side of the Atlantic, however, Boston Fed Chief Eric Rosengren, also a hawk, remains relaxed about inflation prospects. Keeping with the Fed’s tack on inflation, Rosengren said in an online symposium that he expects some sectors to show jumps in prices.
Then he added:
“But what we really want for inflation is kind of the broad-based inflation rate to be at a sustained level of 2%. I don’t think we are going to see that this year. I would be surprised if we see it before the end of next year.”
St. Louis Fed President James Bullard earlier in the week said the U.S. economic outlook is good, and inflation is likely to increase this year. Policymakers would take such an increase “on board,” he said, without showing too much concern.
Meanwhile, the yield on the benchmark 10-year Treasury note rose Friday to 1.34%, almost 20 basis points higher than at the end of the previous week. The rate on 30-year fixed mortgages also rose nearly 20bps from the low of 2.8% earlier this month to bump up against 3.0%.