Inflation is not so transitory after all, according to Federal Reserve policymakers, who have advanced their timeline for raising interest rates to next year instead of 2024.
One might be excused for thinking events have slipped out of the Fed’s control as they scramble to revise their forecasts and projections to keep up with price increases that always seem to exceed their expectations.
In the projection materials released with last week’s meeting of the Federal Open Market Committee, the median forecast for inflation this year as measured by the personal consumption expenditures index rose to 4.2% from the 3.4% forecast in June. Core PCE inflation, stripping out volatile food and energy prices, was put at 3.7% instead of June’s 3.0%.
Even more telling, the forecast rate for core PCE inflation in 2022 was 2.3%, compared to 2.1% projected in June and 1.8% in September 2020, when the FOMC members blithely ignored the longer-term impact of supply-chain disruptions. It is a fair bet that December projections will be even a notch higher.
The projected median Fed funds rate for next year was raised to 0.3% from 0.1%, and 1.0% in 2023, compared with forecasts a year ago of the benchmark rate remaining at 0.1% through 2023.
2 Tests To Determine Bond Buying Taper
What a difference facts can make, especially if you don’t ignore them. Fed policymakers have consistently underestimated inflation and the odds are they still do.
No surprise, then, that the FOMC plans to accelerate its plans to reduce bond purchases, starting most likely as soon as the Nov. 2-3 meeting. Fed Chairman Jerome Powell indicated it might just take one more “decent” jobs report—the September report due out Oct. 8—to meet policymakers’ “test” on maximum employment along with the already-fulfilled test for inflation(!).
As Powell said at his press conference Wednesday after the FOMC meeting:
“Once we've met those two tests, once the committee decides that they've met, and that could come as soon as the next meeting, that's the purpose of that language is to put notice out there that could come as soon as the next meeting.”
The hawks on the FOMC—the ones who’ve been suggesting for some time the Fed should taper its asset purchases sooner rather than later—are ascendant.
“I support starting to dial back our purchases in November and concluding them over the first half of next year,” Cleveland Fed chief Loretta Mester said at an Ohio Bankers League event.
Her counterpart at the Kansas City Fed, Esther George, told the American Enterprise Institute:
“The rationale for continuing to add to our asset holdings each month has waned.”
The Fed has been buying $80 billion of Treasuries and $40 billion of mortgage bonds each month as critics have warned the time for such stimulus has long since passed.
The other big question, as George pointed out, was how and when the Fed could start shrinking its balance sheet, now swollen to $8.5 trillion from those monthly bond purchases. Just maintaining it at that level is accommodative and would hold down long-term interest rates.
Both regional bank presidents made it clear that they were among those referred to by Powell who wanted to end the bond purchases by the middle of next year and start raising rates before the end of 2022.
The congressional standoff on the debt ceiling complicates the Fed’s maneuvers, as Treasury Secretary Janet Yellen warns the government could run out of money next month unless Congress acts to raise or suspend the ceiling.
There is speculation that the Fed could be forced to adopt an extreme measure such as buying up Treasuries that would fall into default and selling those not in default from its own portfolio to ease strains in financial markets. Both Powell and Yellen supported such a backstop measure when a similar stalemate occurred in 2013, though reluctantly.
Democratic Party Politics Dog Powell Reappointment
Looming over everything is the question of whether Powell will be reappointed to head the Fed. His nomination for a second term, though widely favored and considered likely, has fallen into the maw of the Democratic Party’s ideological split, as progressives are pushing for a new chairman to realign Fed priorities.
The nomination has become part of a wide-ranging debate in the party over big spending bills and the role of government. Congressional votes expected this week could reveal how that debate is going.