Fed on Tightening: Mixed Messages
Chairman Jerome Powell said repeatedly in answering questions after the Federal Reserve meeting last month that there had not even been talk of talking about reducing monthly bond purchases. Despite his assertion that there had been no move — even two stages removed — to tighten, minutes of the discussion released last Wednesday tell a different story.
A “number” of policymakers had suggested at their session on April 18 and 19 that if there was a significant move toward policy goals relating to inflation and employment, it may be time to “begin discussing a plan for adjusting the pace of asset purchases.” The yield on 10-year Treasurys surged from 1.63% to 1.69% after the minutes’ release Washington afternoon Wednesday but ended the week at 1.62%, down for the week.
What was going on? First, there was a reason for investors to be complacent despite the message from the minutes. Since the Fed officials met last month, although the latest annual consumer price inflation figure came out at a far-above-consensus 4.2%, we also learned that only 266,000 jobs were created in April compared with the almost 1 million that had been anticipated. Perhaps the recovery was slowing after all, and the surge in inflation was temporary?
A far more important factor, in my opinion, was the markets’ confidence that the central bank was unlikely to be a party pooper by cutting bond purchases anytime soon. After all, Fed Vice Chairman Richard Clarida had asserted after the inflation report that though he was “surprised” by the number, it was too soon to tighten. He assured investors that inflation would return close to the Fed target of 2% in 2022 and 2023. Chair Powell also has a record of pivoting swiftly from tighter policy if markets are rattled.
If investors switch their gaze toward fundamentals and away from bland assertions by senior Fed officials, they will find sufficient reason to be concerned about inflation despite the current low bond yields. Rather than blame the April figure on just a base effect — depressed prices in April 2020 — or used car prices, look at the latest University of Michigan Consumer Sentiment numbers. Consumers expect 4.6% inflation over the next year, even higher than April’s 4.2%. A significant minority, 43%, anticipate that prices can rise by 5%. Over the next five years, consumers expected this month that prices will rise by 3.1% per year, up sharply from the 2.7% they anticipated just a month earlier.
Unlike the Fed, participants in the Michigan survey were concerned about the various sectors that prices were rising in — gasoline, homes and cars. Consequently, a portion of the demand surge that pushed up prices was not one-time but a move to buy goods before further price increases set in. That is how inflation psychology builds!
How about the low level of job creation last month? Does that not suggest slack in the labor market and, therefore, potential for price increases to moderate? The labor force participation rate for 25 - 54 year olds continues to be well below the 83% figure at the start of 2020 even after discounting for a parent staying home for childcare. In turn, this suggests that the slack in the labor market that the Fed perceives will not be remedied just by increasing the money supply through bond purchases.
Just more support for a basic fact — job creation requires structural changes such as worker training to meet the needs of a changing economy. Instead, if the Fed believes that the near-doubling of its balance sheet since the start of 2020 could transform a plumber into a nuclear physicist to meet rising demand, all it will have is inflation, not jobs!
Note
: Thank you for your readership! There will be no SriKonomics next weekend as I will be driving cross-country from New York City to Santa Monica — a long cherished dream of mine. The next piece will be published during the weekend of June 5 - 6.
Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
May 23, 2021
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