The Fed’s rate-setting body, the Federal Open Market Committee (FOMC) will meet this week. It is quite likely that that will put a dampener on markets for a few days as traders and investors await the statement and comments that will follow the meeting. Investors, however, shouldn’t be tempted to try and second guess the Fed here. Patience will be a virtue this week.
Fed Chair Jay Powell is expected to use this occasion to make his change of heart on the durability of inflation official, by bringing forward the timeline for ending asset purchases so as to make way for interest rate hikes by somewhere around the third quarter of next year. According to Reuters, that is what most economists and analysts expect, but traders will be watching this week’s releases and comments for hints that rate hikes will come sooner than that.
As inflation has taken hold in America over the last year or so, Powell has, until very recently, insisted that it would not last, famously describing price rises as "transitory." There are perfectly logical reasons to believe that to be the case. We have, after all, seen unprecedented conditions over the last couple of years, with a thriving global economy almost completely shut down, then quickly re-opened. As that re-opening happened, a combination of a lack of immigration, a rethinking of the value of work after an enforced break, concerns about health, and several other things has resulted in labor shortages that have, disrupted supply and distribution. Short supply leads to price hikes, but abnormal conditions are temporary by nature so surely, we should be back to “normal” before long, right?
That, 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 that Covid would disappear quickly, then his appointee Powell would also have been right when he said that things would quickly return to normal in the economy. The problem is both have been proven wrong by events. The development and deployment of effective vaccines was achieved at a record-setting pace under “Operation Warp Speed” but still, a year and a half after the shutdown, only 57.5% of the world's population is fully or partially vaccinated. As we are all too aware, that isn’t enough to prevent mutations that cause problems, and the combination of ignorance, misinformation, and inequity of vaccine supply that are still with us makes it likely that will be the way for a while.
Covid disruption to international trade is therefore still a thing, and the longer that disruption goes on, the more people seem to be rethinking the concept of work. The current labor shortages are concentrated in low-paid, hard jobs, where the added risk of health problems and dealing with angry, recalcitrant members of the public or co-workers make it simply not worth the pay that is offered.
Inevitably, wages are beginning to rise in that environment, which brings us to the second thing that makes the assumption that rate hikes won’t come until late next year questionable, the nature of inflation.
The problem with inflation is that it tends to be cumulative and self-feeding. Price rises mean that people need more money just to stand still economically, so they demand higher wages in order to take care of the basics like food and gas. That forces producers to increase prices, which results in higher wage demands, which increase costs and lead to higher prices, an upward spiral. If this bout of inflation were really temporary, it would have ended before price increases caused wage pressure, but a combination of longevity in price hikes and a re-evaluation of work means that we could now be past that point.
The question then becomes whether Powell, now that he has altered his view, will focus on that long-term dynamic and danger, or will he take heart from last week’s CPI data that suggested that price increases were still driven mainly by commodity prices and therefore could still prove to be "transient" after all. If the latter were to turn out to be true, then acting too swiftly could cause a rapid slowdown, and even possibly a crash.
In other words, this Fed meeting could go either way. The FOMC could make some subtle changes to language and the "dot plot," the chart of members’ expectations for future interest rate levels, that indicate change is coming quickly. That is what most expect, but there is a chance they could revert to their original, "transient" expectations, in which case even Q3 2022 may look a bit soon to expect hikes. That is a big delta, and I wish I could confidently tell you which way it will go so you could position accordingly. However, conflicting messages from FOMC members and from economic data make that just about impossible, so a “wait and see” approach this week is called for.
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Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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