The Federal Reserve today concluded a pivotal meeting of its rate-setting body by pledging to keep interest rates close to zero and announcing that later this month it will begin to unwind one of its largest and most unprecedented market interventions in stride. of the pandemic.
Wall Street was awaiting remarks from Fed Chairman Jerome Powell on the stubbornly persistent inflation that is starting to create interest rate concern on Wall Street.
In his prepared statement, Powell continued to use the word “transient” to characterize the inflationary climate, although he also acknowledged that the disruption in the supply chain created “significant price increases” in some parts. economy.
Market watchers had predicted that Powell would reconsider how he characterized the current level of inflation, given that the long duration of higher prices seems to stretch the definition of the term. “If this inflation is not transitory, what is it? said Zhiwei Ren, Managing Director and Portfolio Manager at Penn Mutual Asset Management.
“I’m not sure if the word ‘transient’ will be used that frequently,” said Greg McBride, chief financial analyst at Bankrate. “The Fed has recognized that this could persist for longer and at higher levels than expected,” he said.
Keith Buchanan, portfolio manager at Globalt Investments, said the “stickier” nature of current inflationary pressures presents a challenge for Powell.
Atlanta Fed Chairman Raphael Bostic went even further, calling the word “transient” a “dirty word” in a speech at the Peterson Institute for International Economics Tuesday.
Bostic said he expected supply chain disruptions driving up prices to persist, saying: “By this definition, therefore, forces are not transient.”
Conversely, given that this inflation surge is supply chain driven, Powell is likely to maintain the position that it does not pose a long-term threat to economic growth, McBride said.
“Inflation is in the foreground as a problem and will be for the next six to 12 months, easily, but that alone is not going to dictate the action of the Fed. Economic growth, the labor market and even geopolitical concerns could very likely come into play, ”he said.
The backdrop to the conversation around inflation persistence is the Fed’s long-awaited cut. As of June 2020, the central bank has bought $ 120 billion in bonds – $ 80 billion in treasury bills and $ 40 billion in mortgage-backed securities – each month to add liquidity and keep the system running smoothly. financial. On Wednesday, Powell said the Fed would start cutting those purchases by $ 10 billion and $ 5 billion, respectively, later this month. The Fed will continue to pull out of these increments, although Powell said the bank was “ready to adjust the pace of buying if changes in the economic outlook warrant it.”
“It’s an important meeting. This is the Fed meeting we’ve been waiting for since May or June, ”said Lawrence Gillum, bond strategist for LPL Financial. Market watchers expect the reduction to begin either later this month or in December, based on comments Fed officials began providing this summer.
Although James Bullard, the Fed’s regional chairman in St. Louis, recently suggested While tapering could end as early as the first quarter of next year, most market participants believe the Fed is more likely to slow down and close these bond purchases entirely by next June.
“They talked about giving the markets advance notice. This Fed has been very deliberate in its communications strategy, ”said Gillum.
Powell has been careful to assure – and reassure – investors that the liquidation of those monthly purchases is a separate activity and not related to rate hikes.
But while the Fed has telegraphed its intention to keep rates close to zero until 2023 or the end of 2022 at the earliest, Wall Street is moving forward with expectations of a more hawkish policy.
“A lot of questions and concerns have now moved to the start of the rate hike cycle,” Buchanan said. “Of course, the markets are supposed to be looking to the future. I think the focus will be on the cycle of rate hikes and how quickly that happens. “
Communication is paramount right now. The last thing the Fed wants to release is a sense of panic.
With a number of inflation metrics remaining sharply elevated, the CME’s FedWatch tool finds that markets are expecting two rate hikes in 2022 alone.
“I’m going to watch how much he talks about inflation and how much he pushes back market expectations,” Ren said.
“I think and expect President Powell to talk about the fact that the tapering is not tightening and there is no time to start raising interest rates,” said Gillum. . He acknowledged the divergence between the Fed’s policy statements and Wall Street sentiment. “They’ve been talking about it for several months now, but it seems the market isn’t listening to them,” he said.
Experts said, however, that recent measures such as lower than expected GDP growth and job gains could give the Fed more justification for keeping rates close to zero.
“This is one of the reasons we are delaying rate hikes. The job market has not yet fully recovered, ”said Gillum.
“Slower growth will actually alleviate concerns about an ‘overheating’ economy and support President Powell’s view that interest rates should stay at current levels until the second half of 2022,” said Chris Gaffney, President of Global Markets at TIAA Bank.
Gaffney added, however, that estimating the persistence of inflation into the near future is a miscalculative exercise, even among policymakers. “Inflation expectations continue to rise across the world, so investors will be watching closely how central bank views on inflation fit the data,” he said.
Investment experts have said the stakes are high for Powell to avoid giving markets the impression that the Fed is pivoting or readjusting its policy framework on the fly. “Communication is paramount right now,” Buchanan said. “The last thing they want to release is a feeling of panic… if they lose their credibility, they lose their effectiveness,” he warned.
“If the Fed is more hawkish than the markets expect, we could see a bout of volatility,” said Gillum. “There is always that risk of a hawkish upward surprise.”