Is Fed Chair Powell Moving To Reduce Monetary Accommodation?

Will there be any mention of the start of tapering at the Federal Open Market Committee meeting?

At long last, will the FOMC come up with an important policy at its meeting on July 27-28? I would like to reexamine the economic indicators related to prices before the committee, and consider how serious the situation with inflation has become.

Inflation Is Likely To Be Prolonged after All

Federal Reserve Chair Jerome Powell gave his semiannual testimony to Congress on July 14 and 15. At the FOMC meeting held in June, it is well known that the average forecast for the start of rate hikes was significantly brought forward in the interest rate forecasts (dot charts) of senior Fed officials.

This led some to believe that the Fed would make some kind of statement regarding the early start of tapering, but as it turned out, it was just the same old “Powell talk.” In other words, the Fed chairman was eager to dispel the market’s concerns about inflation, saying, “Inflation has increased notably and will likely remain elevated in coming months before moderating. Inflation is being temporarily boosted by base effects.”

Looking at the latest data, it is clear to everyone that upward pressure on prices is increasing at present. Despite this, Powell stubbornly refused to change his view that inflationary factors are temporary. I got the impression that he courageously believes that someday inflationary pressures will recede, and that the causes for concern will disappear in accordance with his judgement.

Of course, Powell’s insistence that inflation is due to temporary factors is based on a certain amount of evidence. The Consumer Price Index for June, released just before his testimony, recorded the highest monthly growth since June 2008 at 0.9%.

However, looking at the details [of the June CPI] shows that used cars rose a massive 10.5% month-over-month, lodging prices rose 7.9%, airfares rose 2.7% and gasoline prices rose 2.5%, but to be sure, all of these were due to temporary factors such as a surge in demand and a shortage of supply.

On the other hand, rents and imputed rents, which are slow to fall once they rise and tend to lead to sustained inflation, have risen, but not spectacularly, at 0.2% and 0.3% respectively. Looking at these figures, we may be able to say that Powell’s assertion is correct.

However, it is also true that the CPI has already increased by 0.6% month on month in March, then 0.8% in April and 0.6% in May, making June the fourth consecutive month of high growth. This may not be very helpful, as last year was in the midst of the COVID-19 crisis, but the year-on-year rate of increase has been steadily increasing: 2.6% in March, 4.2% in April, 4.9% in May and 5.3% in June.

In the usual sense, a rise that lasts three to four months can no longer be called temporary. Inflationary pressures are steadily increasing, and we are now faced with the need to come up with solid policies to deal with them.

Incidentally, the FOMC used the same word “temporary” in the early stages of the last monetary tightening phase, which triggered the tapering shock in May 2013, under then Chairman Ben Bernanke.

At that time, the statement included the phrase “the rise in prices is due to temporary effects”* for more than two years from the end of 2014, but eventually the trend of price increases did not stop after that and the phrase “temporary” was deleted.

It is fresh in my memory that the rate hike was carried out solemnly by the successive chair, Janet Yellen. It may be said that this time [inflation] is temporary for a while, but looking at the data flow, it seems quite likely that the result will be the same as in 2016, does it not?

Beware of Rising Market Inflation Expectations and Rising Rents

It may also be significant that the Reuters/University of Michigan consumer price index, released Thursday, forecast inflation for the year at over 4.8%, the highest level since August 2008.

The Fed is wary of scenarios where rising market expectations for inflation lead to sustained inflation, rather than inflation due to recent temporary factors.

Powell also mentioned this risk in his congressional testimony. In addition to the representative indicator of the difference in yields of ordinary American government bonds and inflation-linked government bonds called TIPS, known as the break even inflation rate, the Fed is closely monitoring developments in inflation expectations by making full use of all kinds of data, including survey results on inflation. It is quite possible that the Fed is wary of the rise in inflation expectations in the last University of Michigan Consumer Index as a precursor to a full-scale rise in inflation expectations.

Moreover, although it was not reflected in the consumer price index this time, it should be noted that rents are on the rise again in urban areas of the United States as economic activity rapidly normalizes. According to Douglas Elliman, a major real estate brokerage firm, the median monthly rent for an apartment in Manhattan in May was $3,037, up 8.8% from April. This was the largest increase in the last 10 years.

Although rents are still down 11.1% year over year, it is highly likely that they will continue to rise as more people move or are transferred on a more active basis. Due to the nature of rents, once they rise, they do not easily fall, leading to long-term inflation.

Rate Hike Ahead, but Tapering Closer than Expected?

In his congressional testimony, Powell clearly stated that it is still quite some time before he will change monetary policy. However, this seems to be in anticipation of the timing of a rate hike. He has already made it clear that he discussed the timing of the start of tapering at the June FOMC meeting, and will discuss it further at the next FOMC meeting.

He also clearly indicated his intention to make any changes to policies known to the market. He also noted [his view] that inflation is a temporary phenomenon, but that the authorities are well equipped to deal with inflation and will act quickly if there are signs of prolonged inflation.

Powell himself may be cautious about an early change in policy. Nevertheless, it seems that he is well prepared for further changes in the situation.

As mentioned above, the change in the dot chart at the June FOMC meeting clearly shows that some of the Fed members, who had previously shown a dovish stance, have shifted course in a hawkish direction.

At the next FOMC meeting, there will undoubtedly be more calls from participants for an early start to tapering. Powell will no longer be able to ignore such calls. It is quite possible that the FOMC will make some specific mention of a timetable for tapering in its statement or in its subsequent press conference. How will the market react at that time?

*Editor’s Note: This quotation, accurately translated, could not be verified.