MNI STATE OF PLAY: Fed Tapers Amid Less Transitory Inflation

The Federal Reserve on Wednesday initiated tapering pandemic-era bond purchases and moved closer to raising interest rates if unexpectedly strong inflation persists next year, while Chair Jay Powell urged patience to allow the labor market to recover from Covid.

The USD15 billion per month wind-down of the USD120 billion monthly asset purchase program came "earlier and faster" than markets had expected at the start of the year, "partly because we see inflation coming in higher," Powell told reporters after the November FOMC meeting.

"The risk is skewed for now, it appears to be skewed toward higher inflation. We need to be in a position to act if in case it becomes appropriate to do so," he said.

"It's appropriate to be patient," he added. "It's appropriate for us to see what the labor market and what the economy look like when they heal further."

Market reaction to the tapering announcement was muted, but fed funds futures showed some bets on three or four rate hikes next year after Powell's press conference.

A STEP BACK

The FOMC in its post-meeting statement continued to describe the recent five months of 4% headline PCE inflation as "transitory" but signaled less confidence in that judgment. Supply-side factors driving high inflation largely reflect factors "that are expected to be transitory," the FOMC said.

"We took a step back," Powell told reporters about the transitory language, a phrase MNI has reported the Fed would edge away from. "It's become a word that has received a lot of attention which is distracting from our message which we want to be as clear as possible."

Supply bottlenecks and shortages "will persist well into next year and elevated inflation as well," he said, though inflation should move down by the second or third quarter. The ISM Services Chair told MNI just before the decision that price pressures will remain intense well into next year as companies struggle to meet demand.

Allowing inflation to run well above target hasn't put the Fed behind the curve, as there is "still ground to cover to get to maximum employment," Powell said.

TIGHT LABOR MARKET

People are still staying out of the labor force because they fear catching Covid or bear caretaking responsibilities, he noted. Schools reopening and lapsing unemployment benefits don't seem to have produced additional labor supply as many economists expected.

On the other hand, "by many measures, we are at a very tight labor market," Powell said. Workers are quitting their positions and employers are posting job opening at record rates, and wages are rising briskly.

The economy could reach maximum employment by the second half of next year, the Fed chair said. "If you look at the progress we made over the course of the last year, if that pace were to continue, the answer would be yes, I do think that is possible."

Most inflation pressures are driven by pandemic-related disruptions and should subside, changes that will be led by the real economy rather than monetary policy, Powell suggested. "Our tools cannot ease supply constraints. We continue to believe our dynamic economy will adjust to the supply and demand imbalances and that as it does, inflation will decline to levels much closer to our 2% longer run goal."

The Fed's balance sheet has grown to USD8.6 trillion from USD4.2 trillion under the QE program. The taper process, if unaltered, is set to last eight months.