What to watch from the Fed this week

TThe Fed’s rate-setting body, the Federal Open Market Committee (FOMC) will meet this week. It is highly likely that this will put the markets on hold for a few days as traders and investors await the statement and comments following the meeting. Investors, however, shouldn’t be tempted to guess at the Fed here. Patience will be a virtue this week.

Fed Chairman Jay Powell is expected to take this opportunity to formalize his change of mind on the sustainability of inflation, advancing the timeline to end asset purchases to make room for rate hikes. interest towards the third quarter of next year. . According to ReutersThis is what most economists and analysts would expect, but traders will be watching this week’s posts and comments for clues that rate hikes will come sooner than that.

While inflation has set in in the United States over the past year or so, Powell, until very recently, insisted that it would not last, describing the infamous price hike as “transient. “. There are perfectly logical reasons to believe that this is the case. We have, after all, experienced unprecedented conditions over the past two years, with a thriving global economy almost completely shut down and then quickly reopened. At the time of this reopening, a combination of a lack of immigration, an overhaul of the value of work after a forced break, health concerns and several other factors resulted in labor shortages. which disrupted supply and distribution. Insufficient supply leads to price increases, but abnormal conditions are temporary in nature, so surely we should get back to “normal” before long, right?

This, however, potentially ignores two things: the nature of the disruption and the nature of inflation.

If Donald Trump had been right on one of the many occasions when he said Covid would disappear quickly, then his person named Powell would also have been right when he said things would quickly return to normal in the economy. The problem is that both have been belied by events. The development and deployment of effective vaccines have been achieved at a record pace as part of “Operation Warp Speed” but again, a year and a half after the shutdown, only 57.5% of the world’s population is fully or partially vaccinated. As we all know too well, this is not enough to prevent mutations that cause trouble, and the combination of ignorance, misinformation, and inequity of vaccine supply that are always with us makes it likely to be. the case for a while.

The disruption of international trade by Covid is therefore still relevant today, and the longer this disruption continues, the more people seem to rethink the concept of work. Current labor shortages are concentrated in difficult, low-paying jobs, where the added risk of health problems and dealing with angry and recalcitrant members of the public or colleagues is simply not worth the pay offered. .

Inevitably, wages start to rise in this environment, which brings us to the second thing that makes the assumption that rate hikes will only come at the end of next year questionable, the nature of inflation. .

The problem with inflation is that it tends to be cumulative and self-sustaining. Price hikes mean people need more money just to stay economically still, so they demand higher wages in order to take care of the basics like food and gas. This forces producers to raise prices, resulting in higher wage demands, which increase costs and lead to higher prices, an upward spiral. If this surge in inflation were truly temporary, it would have ended before price hikes put pressure on wages, but a combination of the longevity of price hikes and a revaluation of labor means we could now have passed that point.

The question then becomes whether Powell, now that he has changed his mind, will focus on this long-term dynamic and danger, or will he take inspiration from last week’s CPI data which suggested that price increases were still primarily driven by commodity prices and therefore might still prove to be “transient” after all. If the latter were true, acting too quickly could cause a rapid slowdown or even a crash.

In other words, this Fed meeting could go both ways. The FOMC could make some subtle changes to the language and to the “dot plot”, the graph of members’ expectations for future interest rate levels, which indicate the change is coming quickly. This is what most expect, but it is possible that they will revert to their original “transient” expectations, in which case even the third quarter of 2022 might seem a bit early to expect hikes. It’s a big delta, and I wish I could tell you with confidence which direction it will go so that you can position yourself accordingly. However, conflicting messages from FOMC members and economic data make this nearly impossible, so a “wait and see” approach this week is needed.

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