The Fed Board has released the post December 2021 FOMC minutes. Please, find below the relevant parts on inflation followed by our comments.
The big news is that the staff has (finally) decided to revise the assumption about underlying inflation. Please, remember that this is the crucial assumption in the staff framework. Everything else in the minutes can be seen as consequential. We are glad that we circulated individual emails to each of you in the last few days about the possible upward revision to pi*.
In our bilateral emails, we wrote: “The overall conclusion is that there is now a very high chance that the staff might have revised up its assumption about underlying inflation. We cannot be sure but we would not be surprised to read it in the upcoming minutes. As for how the staff might have revised pi*, our best guess is that they have used the rule embedded in the FRB-US model (it’s an autoregressive rule anchored at target). In our view pi* now moves up gradually and converges to 2 percent somewhen in 2023/2024.” A welcome (and anticipated) development. Quod erat demonstrandum: what matters for monetary policy on the inflation side is not actual inflation, it is underlying inflation.
Please, do not underestimate the magnitude of this news. The hawkish pivot is real and it is probably underestimated by the markets. For this reason, we have revised our view about the Federal Funds rates: we now expect 4 hikes in 2022 starting in March.
Incoming data – part I
Minutes: Inflation readings remained high, and various indicators suggested that inflationary pressures had broadened in recent months.
Comment: the staff is finally fully on board with the data and the narrative. The staff is not ignoring anymore the clear signals of the data. Overall, a very good news.
Incoming data – part II
Minutes: The projection for U.S. consumer price inflation prepared by the staff for the December FOMC meeting was higher than in the November projection. The near-term outlook was revised up, reflecting faster-than-expected increases both for a broad array of consumer prices and for wages.
Comment: unsurprising, considering that the Fed staff has been upwardly surprised by the incoming data, as specified in our pre FOMC meeting package.
Underlying inflation
Minutes: Over the following two years, the boost to consumer prices caused by supply issues was expected to partly reverse, and energy prices were projected to decline. PCE price inflation was therefore expected to step down to 2.1 percent in 2022 and to remain there in 2023 and 2024. Projected inflation over this period was a little higher than in the previous projection, as supply bottlenecks were assumed to resolve more gradually and as the salience of this year’s higher inflation readings was assumed to raise the underlying trend in inflation relative to the previous forecast. Longer-run inflation was still assumed to remain anchored at 2 percent.
Comment: this is huge. Essentially, the Fed staff has given green light to Powell and the FOMC. The level of pi* has always been crucial because the entire strategy review was not about actual inflation but it was about raising pi* from a bit below 2 percent to target. We also confirm our view that the staff might have used the FRB-US formula (or some modification of it) to set pi* in the decomposition. According to the minutes, core PCE inflation is forecasted to remain at 2.1 percent in 2023 and 2024. This implies in our view that underlying gradually moves up from 1.8 percent in 2021 to 2 percent in 2024. In any case, no matter what is the exact new path assumed by the Fed staff, the message to Powell is clear: pi* is moving and it is expect to converge to target (even under the new path of the Federal Funds rates). In other words, the staff has told the FOMC “you have green lights”.
Needless to say, the Fed remains data dependent.
However, to the extent that data will continue to come in on the strong side, a rate hike in March should be (almost) on autopilot at this point.
Our updated view of the decomposition
Table 1
Note: Details may not sum to totals because of rounding. The “other factors” line includes the contribution of core non-market inflation, as well as the contributions of factors that are unrelated to other fundamentals. The “Board staff” forecast is inferred from the FOMC minutes.
Figure 1
