As the inflation forecast clouds in his eyes, the central banker is prepping the markets for a faster-than-expected end to the massive flood of money seen in recent years. Suddenly, he is uninterested in hearing about the “temporary rise in prices.”
The tailwind on the financial markets is weakening or even threatening to turn around. Lately, investors, who have been spoiled with tons of cheap money up to now, seem to no longer be able to rely on the American Federal Reserve to rush to their aid as soon as prices go down significantly. On the contrary – some market observers suspect that President Joe Biden only extended the mandate for Fed President Jerome Powell on the ungrateful condition and counter asset price inflation and inflationary trends in consumer goods.
In fact, Wall Street stock prices came under slight pressure on Tuesday after a public Senate hearing Fed chairman said that the central bank was ready to accelerate its ultra-cheap money policy despite concerns about a new wave of coronavirus than previously expected. This statement led to speculation that the interest rate-determining body could decide in the middle of this month to end the massive asset purchases, which are currently worth 120 billion dollars per month, in March and then consider raising the key interest rate.
Powell’s remarks suddenly suggest that the Fed is no longer primarily focused on promoting the further recovery of the long hot labor market, but rather on avoiding higher inflation rates. “Risk of higher inflation has increased,” Powell said before the Senate Banking Committee on the side of Treasury Secretary Janet Yellen. The Fed finds itself in a tricky environment in which the conflict between labor market and inflation targets is complicated and exacerbated by the emergence of virus fears.
In fact, the US inflation rate has skyrocketed this year, reaching 6.2 percent year-on-year in October, its highest level in 30 years. The main reason for this is the strong demand for goods and services, which is based on huge monetary and fiscal stimulus measures, but which are also offset by bottlenecks in the supply chain that are only partially related to the reopening of the economy after the pandemic. Even under normal circumstances, the economy does not have the necessary capacities to with the artificial, Keynesian-fueled demand cope, argue the critics of the huge government spending orgies on credit around the world – but especially in the USA and Europe.
It is now being said that the latest variant of the coronavirus could prolong the economic disruptions with inflationary effects. If successive virus outbreaks oust more and more American citizens from the job market, there could even be a wage and price spiral due to an empty job market. The fuse had long been laid because, for example, the agreement concluded between the trade unions and the mechanical engineering company Deere after a long strike provided for significant wage increases and, above all, so-called wage adjustment clauses. Such had contributed to the then high inflation in the 1970s.
In fact, on Tuesday, Powell hinted more clearly than at any earlier point this year that the Fed may be forced to cool the overstimulated economy in order to prolong economic growth.
“To get back to the great labor market we had before the pandemic we’re going to need a long expansion,” said the central banker.
In early November, he and his colleagues announced that they would reduce the monthly asset purchase program worth $120 billion in November and December by $15 billion each. If you want to close the buying activity completely in March, you would have to reduce the purchases in the first three months of the coming year by 30 billion dollars each – and then even “tighten the interest rate screw” if necessary.
During the hearing, the central bank governor openly admitted that he and his colleagues may have made a mistake in their assessment of how long the inflation rate would remain high. Some Fed officials and many other professional forecasters are still assuming that inflationary pressures will ease “in the coming year” at the latest when the pandemic-related disruptions end.
Even if inflation rates should fall again, however, the absolute prices initially remain at the increased level, which permanently reduces the purchasing power of consumers. Obviously, when designing their forecast models, many experts also overlooked the fact that the development of macroeconomic supply cannot simply be extrapolated linearly because the interactions between individual factors are too complex to be realistically represented. In other words, there is a risk that the macro models used will be just as full of holes as the banks’ risk models in the context of the past financial crisis.
It only seems certain that future developments in the economy and on the international financial markets will be more uncertain than in the past, when the central banks and governments were able to stimulate impending setbacks without fear of negative consequences. If you believe skeptics, these strategies have long been overused.
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