Inflation, wage data, the challenge of the Fed’s ‘transitory’ narrative

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The Federal Reserve Building is pictured in Washington, DC, the United States on August 22, 2018. REUTERS / Chris Wattie / File Photo

WASHINGTON, Nov. 1 (Reuters) – Price and wage increases hitting decades-long highs could challenge Federal Reserve officials this week as they try to strike a balance between keeping inflation contained and give the economy as much time as possible to restore jobs lost since the pandemic.

While investors are already betting that the Fed will hike rates twice next year, a much faster and faster rate than policymakers themselves had predicted, economists at Goldman Sachs have become the last to step up. their call for rate hikes – pushing it forward a full year until July 2022.

Until then, Goldman economist Jan Hatzius and others have written that they expect inflation, as measured by the closely watched basic personal consumption expenditure price index, still above 3% – a wave of inflation not seen since the early 1990s and much higher than that of the Fed. 2% target.

Some aspects of the labor market, in particular the labor force participation rate, are unlikely to have returned to pre-pandemic levels and are apparently still below the “maximum employment” that the Fed has promised to restore. before raising interest rates. But at this point, the Goldman team wrote, Fed officials would “conclude that most if not all of the remaining weakness in labor market participation is structural or voluntary” and proceed with rate hikes to ensure that inflation remains under control.

Reuters Charts

“Since the (Federal Open Market Committee) last met in September, the unemployment rate has fallen further, average hourly wages and the cost of employment index have risen sharply, inflation has remained high, “they wrote, challenging the Fed’s narrative that inflation will pass on its own without resorting to a rate hike to tighten credit conditions and slow corporate buying and Household.

CLOSED CALENDAR

The Fed is meeting this week and will issue a new policy statement Wednesday at 2:00 p.m. (6:00 p.m. GMT), followed by a press conference at 2:30 p.m. (6:30 p.m. GMT) by Fed Chairman Jerome Powell. Officials are expected to approve plans to cut their current monthly purchases of $ 120 billion of bonds that would phase them out completely by the middle of next year – a first step on the baseline policies put in place at the start. 2021 to combat the economic fallout from the pandemic.

Fed officials have attempted to separate this decision from their eventual, and more consequential, appeal on when to raise interest rates. The benchmark for a rate hike was set last year when the Fed said its key interest rate would not be increased until the economy returned to peak employment, and “l inflation has reached 2% and is on track to moderately exceed 2% for some time. “

At the time, policymakers believed they would have plenty of time to phase out bond purchases with little inflation risk. Even though prices started accelerating earlier this year, Fed officials said the high pace would prove “transient” and not rush them into a rate hike.

The schedule, however, can crumble on them.

Goldman economists are now seeing a “seamless” transfer from the gradual reduction in bonds to rate hikes next year, a view that matches what currently prevails in interest rate futures markets.

According to the CME group FedWatch As a tool, trading in federal funds futures now involves a greater than 65% chance that the Fed will hike rates in June, just as tapering is expected to end, with a second hike expected in November. A month ago, rate market indicators showed a less than 20% chance of a rate hike in early June and a comparably negligible chance of two hikes next year.

TRANSITIONAL THESIS ‘NOT WELL AGED’

It can be a confusing time when it comes to inflation. Blamed at first by what were to be temporary supply disruptions and increased consumer spending on goods that were becoming hard to come by in some cases, the pace of price increases stayed higher for longer than expected. Read more

Reuters Charts

Commodity inflation is not only expected to slow next year, but to actually reverse in a series of falling prices. But the cost of services should make up the difference, especially if a recent increase in employee compensation proves to be persistent.

Raising wages and benefits will present a particular challenge to the central bank in determining whether employees are paid better because productivity increases, or because labor markets and the number of available workers have been out of sync by the pandemic.

One would be seen as a positive development; the other as potentially increasing inflation risks even higher.

“All of this puts Powell in the hot seat at the November meeting to a much greater extent than it seemed likely a few weeks ago,” as he tried to balance a committee divided roughly evenly among those willing to raise rates next year and those willing to be more patient, wrote Evercore ISI vice president Krishna Guha. Read more

“None of this proves that the transitory thesis will ultimately be wrong,” he wrote, but the “tests to believe that excess inflation will likely turn out to be transitory have not aged well.”

Reporting by Howard Schneider; Editing by Dan Burns and Daniel Wallis

Our standards: Thomson Reuters Trust Principles.


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