Fed Tapers But No Interest Rate Lift Off as Powell Urges Patience

US Federal Reserve Chairman Jerome Powell calmed angst in the market over interest rate rises by signalling there would be none any time soon, but did , as expected, say the Fed would begin tapering its asset purchases.

Currently the Fed is buying assets at the rate of $120 billion a month but now the Federal Open Market Committee (FOMC) plans to scale back those purchases so that by mid 2022 they will have come to an end.

The Fed’s move comes as headline CPI inflation reaches 5.4% in the US. However, the two tests of “substantial further progress” on both inflation and labour market maximum employment have only been met in the case of prices.

Inflation is ahead of the 2% target set by the Fed and this has been the case since the first quarter of this year, while the Fed’s preferred measure of inflation – the employment to population ratio is 58.7% compared to 61% at the end of 2019.

Powell: Inflation not due to tight labor market

Powell said at the press conference yesterday that “there is still ground to cover to reach maximum employment” He added: “The inflation that we’re seeing is really not due to a tight labor market.”

He indicated that although there were “difficulties that high inflation poses for individuals and families”, there was very little that the Fed could do to clear supply chain logjams and shortages that he said was to blame for elevated inflation.

Powell said the Fed thought the supply-demand situation would eventually come back into balance of its own accord as companies adjust, noting that US’s “dynamic economy will adjust to the supply and demand imbalances”. As a result he expects inflation to eventually return to the 2% levels – he just didn’t specify exactly how long the transitory nature of inflation would persist. Indeed, the word “transitory” was sparsely used.

However, Powell was at pains to emphasise that the Fed was not in a laissez faire autopilot mode. On the contrary the Fed is “watching carefully” and would not hesitate to act if general price rises looked like they were becoming embedded.

“We have high inflation and we have to balance that with what’s going on in the employment market. It’s a complicated situation,” said the Fed chairman.

“We don’t think it is a good time to raise interest rates because we want to see the labor market heal further. The level of inflation we have right now is not at all consistent with price stability.”

The Fed’s inflation decisions quandary is reflecting to a lesser or greater degree in the discussions taking place among other policymakers at the world’s major central banks

Fed balancing act between inflation and employment

Ethan Harris, head of global economics research at Bank of America, commenting on the day’s developments at the Fed said: “They really aren’t sure what to make of the recent acceleration in inflation, and they want to gather more data.”

The key US 10-year Treasury note is little changed from the beginning of the week at 1.58%, as markets take the Fed announcement on tapering in its stride, with the Fed’s preparations for the tapering move painstakingly prepared over the previous six months.

If there are further signs of inflation building and in particular of wage rises being bid up to maintain purchasing power, then the Fed might be forced to change its tune, raising fears that it could end up being behind the curve and forced into larger more panicky response on interest rate lift off.

But for now the Fed is of a mind that employment conditions are still not sufficiently strong and inflationary pressures transitory in nature.

Michael Feroli, chief US economist at JPMorgan Chase provided a handy summation of the Fed’s thinking. For now it is “balancing the risk you’re not at full employment against the risk you’re going to overshoot inflation. Right now, employment is a greater concern.”