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The Federal Reserve is fast approaching an inflection point that will clarify whether a string of recent high inflation readings will in fact subside as some policymakers expect, or force the central bank to raise interest rates as early as next year, ex-Fed officials told MNI.
"Supply chain constraints are clearly going to last longer than they hoped—well into the second half of next year in many sectors," said Jeffrey Lacker, former president of the Richmond Fed, noting that base year effects have already petered out. Six-month inflation is now running at a 7.2% annual rate, Lacker said.
"As long as it's just supply chains, they can hold on a little longer. But the issues are pass-through and expectations, and on those fronts the data continues to erode."
As officials such as Atlanta Fed President Raphael Bostic and St Louis Fed President James Bullard break ranks with the Board's line that higher inflation is "transitory" -- Bostic stuck the word on a swear jar this week -- former policymakers and staffers agree the term is becoming increasingly fraught.
"The transitory part is now accepted as a long transition, and increasingly a smaller part of the story," Thomas Hoenig, former president of the Kansas City Fed, told MNI.
"Demand pull from major increases in government spending and transfer payments, a large savings balance to be spent, and expected additional spending for infrastructure and social spending will increase inflation further and change expectations."
U.S. inflation rose 5.4% in the year to September, a fifth month of readings above 5%. Even core CPI, which excludes food and energy prices, jumped 4% year-over-year, twice the Fed's official target for the headline figure.
"Also, it makes less sense to speak about core inflation when food and energy price increases are less transitory than once thought," said Hoenig.
"Inflation may come down later next year, depending on the transition time, but I suspect, although I don't know, far less than to any 2% figure. And tightening also will be difficult given the mood of the country."
He cited a small business survey showing "virtually everyone is raising prices," and said trimmed mean numbers are drifting higher. Inflation expectations as measured by consumer surveys like those published by UMich and the New York Fed are also on their way up, he said.
The Fed's September meeting minutes, published Wednesday, conceded that "supply constraints in product and labor markets were larger and likely to be longer lasting than previously anticipated."
Because of this, "most participants saw inflation risks as weighted to the upside," the report said, with some calling for careful monitoring of rent inflation as a potential driver of underlying price increases.
The rent index rose 0.5% in September, while the owners' equivalent rent measure climbed 0.4%. New vehicles prices jumped 1.3%, reversing the prior month's decline, while household furnishings and operations gained 1% on the back of furniture, bedding and appliances.
Ex-Fed board economist Joseph Gagnon was cautiously sanguine, saying the latest CPI data "falls between the transitory and persistent camps," with some prices falling and others rising.
"A monthly core increase of 0.2% does not seem worrisome. But we won't really have a good read on persistence until next year."
Rising inflation pressures are making it harder for the Fed to divorce its likely imminent tapering of bond purchases from an eventual start to interest rate increases, MNI has reported, citing ex-staffers.
Financial markets have started to price in at least one rise in the federal funds rate at the end of 2022, a suspicion confirmed by the minutes, which showed "a number" of officials inclined in that direction.
However, Lacker noted that pending nominations to the Fed's board, in addition to looming replacements at the Dallas and Boston regional Feds, make any guessing game about the timing of monetary tightening more perilous.
"On rates, everything awaits the administration's nominations and Senate confirmation," he said.
Not only various board seats are potentially up for grabs with looming retirements, Powell's reappointment to Fed chair has also come into question in recent weeks, with Gov. Lael Brainard seen as a possible replacement.
"A lot hinges on that process, and it seems unlikely that it will produce strong signals of willingness to take aggressive action to fight inflation. That suggests inflation expectations are likely to continue to erode for the next few months."