Powell: “Price increases have spread more widely.”
Comment: finally, the Chair is acknowledging what the core PCE price changes distribution has been signaling for months. This is a positive development because it means that the Fed staff and the Chair know that inflationary pressures have been growing below the surface and are aware of the associated risks.
Powell: “the term “transitory” refers to not leaving a permanent mark on prices.”.
Comment: this statement has received a lot of attention and comments. However, it is no surprise to us. Indeed, in the Fed staff framework, the word “transitory” means that actual/observed inflation does not leave a print on underlying inflation. The issue in this dimension is that the Fed has not been able to communicate effectively the definition of “transitory” because it never defined “underlying inflation” and never explained the Fed staff framework.
Powell: “it’s time to say goodbye to the term “transitory” when it comes to inflation”.
Comment: as explained above, the use of the word “transitory” has created a lot of confusion. Not only, but as discussed several times in private meetings, in our view the incoming data signal that inflation will remain above target in 2022. Even more importantly, the incoming data have been pointing to significant upward risks to the staff assumption of underlying inflation (indeed, measures of trend inflation and inflation expectations point to underlying inflation at or above 2 percent – see our Brookings slides). We continue to believe that the Fed staff will wait until 2022 before revising its underlying inflation assumption. However, it seems that the FOMC is willing to consider the criteria met before the staff.
Powell: “The baseline expectation is that inflation will fall over the course of next year.” […] However: “the risk of persistently higher inflation has increased. We will use our tools to make sure higher inflation doesn’t become entrenched.” […] “Inflation risks have increased, but “generally the higher prices we are seeing are related to the supply and demand imbalances traced directly back to the pandemic and reopening of the economy”.
Comment: Powell’s words reflect the uncertainty around the forecast. On the one hand, he continues to think (in line with the Fed staff framework and forecast) that inflation will fall significantly in 2022. On the other hand, he is aware that the risks are all skewed to the upside and he remains uncertain that inflation will land close to target, in part due to continuing supply disruptions and strong demand.
Powell: “the Fed’s inflation test has clearly been met”.
Comment: see above comment about term “transitory”.
Powell: “The economy is very strong and inflationary pressures are high, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting, perhaps a few months sooner.” “It’s reasonable to think about wrapping up taper a few months sooner. We will talk about speeding up taper at the coming fed meeting”.
Comment: It is important to notice that Powell referred to the possibility of talking about a faster tapering at the December meeting. To us, this is no surprise because this was already our baseline before hearing from Powell. Following his words, we continue to believe that the most likely scenario is for the FOMC to have a discussion at the December meeting and announcing faster tapering in January (80% probability) but we also now attach a 20% probability that the faster tapering will be announced in December. The Fed is, by definition, data dependent. The next labor market and CPI reports will dictate the date of the announcement.
Powell: “there’s still is a three-part test for raising rates, in the coming meetings, I will say inflation conditions have been met”.
Comment: see comment about term “transitory”. However, we also take Powell’s words as an opening to the possibility that lift-off might happening earlier than anticipated. We are working on our “Pre December FOMC meeting package” will include a revised Taylor rule. We will update you toward the end of the week.