Jerome Powell, who has been nominated for a second term as chairman of the fed, has acknowledged, after some months of optimism where he has been insisting that the pandemic surge in inflation was largely due to transitory forces that, in fact, inflation is proving to be more persistent, and therefore, it will last longer than initially expected. After his words, the fed has decided it is probably a good time for removing the word transitory from their discourse.
His words have had some effect in the asset management industry, and we have received the first commentaries from professionals within the industry. Some of the views, as commented by Nikolaj Schmid, from T. Rowe Price, are that the Chairman is somewhat uncomfortable about the inflation process and he left observers with an impression of an FOMC that is about to take a slightly more hawkish turn.
After the news of the new variant Omicron, and its effects it might have in the markets, the words from Powell, seemed less dovish than expected for the market participants.
We have received some commentaries from professionals within the industry, stating their views on the announcement. We had the commentaries from T. Rowe Price and Mediolanum International funds.
Nikolaj Schmidt, Chief International Economist at T. Rowe Price
During his testimony to the Senate Banking, Housing and Urban Affairs Committee, the Chairman of the Federal Market Open Committee (FOMC), Jay Powell, said that it was time to retire the term “transitory” when discussing inflation. Did Powell hereby indicate that the inflation pressures are permanent? Not quite. During the question and answer session of the hearing, Powell said that there is great confusion about what the term “transitory” means.
To most people, transitory refers to a time interval but in central bank speech, transitory means something that does not have a lasting impact on the inflation process, i.e. something that does not require a monetary policy response.
According to Powell, it is appropriate to retire the term transitory to enhance communication between the Federal Reserve and the public. To an economist on the outside observing the process, the breakdown in communication associated with the term transitory has reached a point where the public is losing some faith in the Fed.
More relevant for monetary policy, Chairman Powell acknowledged that, in his view, it would be appropriate for the FOMC, in its upcoming meeting, to discuss whether the tapering process should be accelerated. Powell made these comments amid an environment of elevated concerns about the economic implications of the Omicron-covid outbreak.
In my view, many market participants had, given the virus concerns, expected Powell’s communication to tilt somewhat dovish – but this was not the case during Tuesday’s testimony. Last, in response to questions, Chairman Powell acknowledge that the Fed, and the economic forecasting community at large, had been too optimistic in their outlook for inflation. The problem in the forecasting process has been related to the difficulties in understanding a very unusual, pandemic related, distortion to the supply side of the economy.
In my view, Chairman Powell was, during his Tuesday testimony, more hawkish than the market had anticipated. Observers of the testimony could clearly conclude that the Chairman is somewhat uncomfortable about the inflation process and he left observers with an impression of an FOMC that is about to take a slightly more hawkish turn.
However, the Chairman was non-committal: the future deliberations by the FOMC will be predicated on additional information about the Omicron-covid outbreak. In case this information turns out to be of greater concern, the FOMC will respond appropriately. Admittedly, the bar for a slowing the current taper program or the bar to deliver additional stimulus has been set extraordinarily high indeed.
Implications for financial markets: A further tightening of monetary policy amid the uncertain Omicron-covid outbreak presents a challenge to the financial markets. It seems highly likely that the Omicron-covid outbreak will have some negative repercussions for growth. Extrapolating from Chairman Powell’s comments on Tuesday, the Fed is not inclined, at the current juncture, to roll out additional monetary support to keep financial conditions accommodative.
A more hawkish Fed amid a backdrop of slower growth should lead to a flattening of the US yield curve with the front end moving higher and the back end rallying. In turn, this bear flattening of the yield curve lends further support to the US dollar and will raise the volatility of the equity market. Over time, these factors are likely to lead to a tightening of financial conditions. In turn, this tightening of the financial conditions will become a brake on global growth. Amid a somewhat more hawkish Fed, let us hope for benign news around the transmissibility and severity of the Omicron-Covid virus.
Charles Diebel – Head of Fixed Income at Mediolanum International Funds
The hawkish tilt form the Fed has moved their statements in line with market expectations and it now looks likely the taper will be expedited quickly and completed by March. This will allow rates to start moving higher from June onwards with market pricing now for 2 to 3 hikes in 2022. If anything the risk are skewed to a faster pace than this given the level of inflation and ongoing pace of activity. Obviously set against recent virus concerns volatility will remain elevated but unless there is a major growth side effect, we would expect the FOMC to lift off next year and potentially at a faster pace than currently discounted by the market