Fed Governor Jerome Powell showed himself to be an impressive operator in his testimony to Congress last week. In his previous testimony on 28 September, he insisted that inflation would fall back to 2%. His 30 November testimony said that it was time to ‘retire the word transitory’ from discussions of inflationary prospects. Markets immediately priced in a faster tapering in QE, earlier rises in interest rates and knocked 1.3% off the value of the S&P.
Cynics pointed out that the main factor that had changed since the September testimony was that Powell had since been reappointed by President Biden and could therefore now say what he wanted to say. Technically, he still awaits confirmation by the Senate but if his appointment were to be derailed on account of his apparent change of mind the US markets would take a much bigger pasting. It is unlikely that the Senators would want to be seen to cause such a market collapse hitting the wealth of their constituents.
There are three key follow up questions. Is Chairman Powell right to be more concerned about inflationary prospects? What does this mean for the likely course of policy in the US? And how will the likely more aggressive trend in US policy tightening affect other countries including the UK?
We at Cebr have been closer to the inflation hawks than the doves consistently through this cycle. Although we are not by any means hard line monetarists, we do accept that the amount of money in circulation affects the real economy, especially through its influence on asset prices. And the jump of a fifth in the US money supply in first part of 2020, with double digit growth still continuing, has been an important factor boosting property prices and sustaining equity and bond prices. On top of this the supply disruptions caused by Covid are abating only slowly and are now expected to continue through the first half of next year. Prices of many commodities have slipped back from their peaks of a few weeks ago but most now seem to have stopped falling. Unfilled vacancies in the US are also historically high at 10.4 million compared with a pre pandemic peak of 7.5 million leading to upward pressure on wages.
So, we are glad that Chairman Powell, like the repenting sinner, has come over to our side. While the purists amongst us find it hard to admire his apparent duplicity, his approach was probably that most likely to ensure that President Biden appointed a Fed chairman who was concerned about inflation.
The markets have now priced in an orderly pace of tapering of quantitative easing with bond buying ending around April next year and probably two rises in interest rates thereafter in 2022.
And yet inflationary expectations have been consistently trending upwards and it seems quite possible that the policy tightening (in reality policy being made slightly less loose) could be accelerated compared with current market expectations.
Emerging markets typically react in a more highly geared fashion to US monetary policy changes and it seems possible that countries like Turkey and Argentina will be forced to respond.
What about the UK? Many of the inflationary signals in the UK mirror those in the US with a tightening labour market, supply shortages and permissive monetary policy driving asset price inflation. And the UK’s uncomfortable post Brexit trade transition means that policy makers would be unlikely to want to follow a monetary policy that pushes up the exchange rate. So for them, the likely faster pace of tightening in the US makes it easier for the MPC to tighten policy without risking an upward surge in sterling. Moreover, tightening in the US, plus its knock-on effect in other countries, will remove some of the international inflationary momentum. And while the impact of the Omicron variant is as yet uncertain, we suspect that UK rate rises will be a bit faster than is factored in by the consensus view, with a lift off in interest rates on the books as early as February.
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Douglas McWilliams firstname.lastname@example.org phone: 07710 083652