Home Business framework Fed faces showdown as supply, demand and ‘patience’ collide

Fed faces showdown as supply, demand and ‘patience’ collide


The Federal Reserve building is seen in Washington, United States, on October 20, 2021. REUTERS / Joshua Roberts

WASHINGTON, Oct.27 (Reuters) – Federal Reserve officials face a ticking clock in their ability to ignore high inflation and now navigate their own sense of patience and risk, and a U.S. economy hampered by tangled supply chains, slow hiring and high consumption demand.

The combination of supply bottlenecks and an increase in household incomes fueled by government aid linked to the pandemic has pushed up the personal consumption expenditure price index, a key measure of inflation. , to a 30-year year-on-year high in August.

Policymakers still expect the pace of price hikes to slow down without the Fed pushing the process by raising interest rates earlier and higher than expected.

Yet this judgment is now based on a race, indeed. Will disruptions, such as saving 100 ships at the Los Angeles-Long Beach port complex in California, go away before households exhaust the estimated $ 2,000 billion in excess savings accumulated during the pandemic? And will this happen before the recent price hikes show up in public expectations for future inflation?

The latter may already be starting up. An index of Fed inflation expectations tracked by senior US central bank officials has risen for five consecutive unprecedented quarters. At 2.06%, it is above the Fed’s 2% target and is expected to rise. Consumer expectations have also jumped. The Conference Board said on Tuesday that its survey of one-year consumer inflation expectations for October reached 7.0%, the highest since July 2008.

Bond markets, also anticipating more inflation, anticipate an earlier start and a faster pace of the Fed’s interest rate hikes.

Reuters Charts

“At first, patience was easy,” Fed Governor Randal Quarles said last week. “The fundamental dilemma we face (…) is this: demand, boosted by an unprecedented fiscal stimulus, has outstripped a temporarily disrupted supply.” Yet the economy’s “core capacity” remains intact, and Fed officials want to keep interest rates low for as long as possible to let employment rise.

“Restricting demand now, to align it with a temporarily interrupted supply, would be premature,” Quarles said, but “my focus is starting to turn more completely… to whether inflation begins to descend. “


The Fed is holding a policy meeting next week and is expected to announce its intention to phase out its $ 120 billion monthly asset purchases by mid-2022. By next summer, the path of the Inflation, inflation expectations and job growth will determine whether the central bank accelerates the date of lifting its target interest rate from the current near zero level.

A year ago, before the arrival of COVID-19 vaccines and at the start of a devastating wave of infections, the prospect of increased borrowing costs seemed distant. Only four Fed policymakers predicted the need to hike rates before 2024.

Now, half of the 18 policymakers are forecasting a hike in 2022, a move that would come as Democratic President Joe Biden’s administration funds new spending and likely before employment returns to pre-pandemic levels. This could complicate Democrats’ efforts to maintain control of Congress in the November 8, 2022 election.

Reuters Charts

Fed Chairman Jerome Powell noted the emergence of “tension” between the central bank’s employment and inflation targets. Fed Vice President Richard Clarida asked in April when he feared the Fed’s expectations of “transient” inflation were wrong, “the end of the year” quoted. Fed Governor Chris Waller set the same schedule last week.

“We seem to be at an inflection point and the question is whether some of the old problems are coming back to haunt us,” said Peter Ireland, professor of economics at Boston College.

It’s a choice Fed officials hoped to get around with a new policy framework designed to capture job gains they say have been missed in past business cycles when interest rates were raised too soon. .

This framework depends on inflation, labor markets and other sectors of the economy behaving as before. For now at least, the pandemic has cast doubt on that premise.

It wasn’t just things like a global shortage of computer chips, capacity constraints in building warehouses, or other supply issues that have stretched the Fed’s “transient” inflation narrative. Household behavior and the actions of elected officials also obscure the horizon.

Reuters Charts


The Biden administration’s upcoming spending is unlikely to approach the explosion of 2020 and early 2021, when federal payments boosted household incomes despite widespread unemployment. Its expected decline could dampen demand.

But some pandemic programs remain and debate continues over whether to make them permanent or add other social spending and infrastructure projects. Recent research by San Francisco Fed staff has argued that between spending already incurred and the fact that job postings have increased beyond the number of unemployed looking for work, “the economy may already be in a state of heat “with rising inflation, albeit only temporarily.

Other data and surveys point to the same conclusion: that the surge in workers and job growth that Fed officials have banked on to boost output and ease price pressures may not materialize, at least not anytime soon.

Statistics compiled by the Atlanta Fed and the Kansas City Fed show that labor markets are generally tighter than reflected by the current overall unemployment rate of 4.8% or the roughly 5 million jobs still missing. in the February 2020 workforce.

Reuters Charts

Job site Indeed found that among those who were not “urgent” looking for work, the main reasons were the availability of cash reserves or being in a household with a working spouse – possibly implying a slower return to normal if preferences have shifted towards less intensive work. According to a study by the St. Louis Fed, 2020 saw perhaps 3 million “excess” retirements, which would represent most of those still absent from the workforce.

As a result, Fed officials seem increasingly open to the uncomfortable possibility that the inflation they thought they had beaten will turn out to have returned faster than the jobs and workers their policies were meant to attract.

“It goes without saying that the Fed feels burnt by the last business cycle,” Ethan Harris, global economist at Bank of America, wrote recently. Interest rates were raised, but inflation never reached the Fed’s 2% target and potential job gains were left on the table.

But between possible shifts in household preferences, restructuring due to the pandemic and some signs that inflation expectations could rise, Harris wrote, “the Fed narrative faces challenges on several fronts.

Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao

Our Standards: Thomson Reuters Trust Principles.