A faster tapering. A closer rate hike. These are the expectations of analysts and investors for the Fed meeting in December, which could therefore mark a change of pace for US monetary policy. President Jerome Powell, reconfirmed in office by Joe Biden, who preferred him to Lael Brainard, a “dove” – who will in any case be vice president – has clearly said that US inflation can no longer be defined as temporary.
An inflation that is no longer transitory
What does it mean? The transience of inflation is not an economic notion, but it is part of the jargon that the Federal Reserve has adopted to define its strategy. Transiently high prices are prices whose increases do not transfer to expectations and therefore should not be countered by monetary policy: they are generally the determined increases “on the supply side”, and a typical case is often that of expensive oil. Monetary policy can correctly be understood as the management of inflation expectations: if they do not change, there is no need to intervene, either verbally or in fact.
Extraordinary savings and fiscal stimuli
An inflation that is no longer transitory is instead an inflation that can have an impact on expectations, and therefore must be countered. It is known that US price increases are also linked to demand: the extraordinary savings made during the pandemic are now being spent and fiscal policy is heavily skewed in favor of supporting families and businesses. Not surprisingly, all sectors are affected by the increases and not only those directly affected by supply interruptions. The result is a sharp drop in real wages, which certainly does not help the economy (which in any case has already exceeded pre-crisis levels in terms of GDP).
Expectations under control
It is no coincidence that Powell’s change of perspective came about at a time when expectations, in market measures, threatened to break free: if the inflation swap rates 5y5y, relating to the period 2026-2031, continued to oscillate between 2 and 2.5% – a reassuring sign because it is consistent with monetary policy objectives – five-year break evens (expressed by the difference between the yields of indexed and non-indexed securities) had jumped over 3%. The president’s words were enough to bring these expectations down, albeit to an extent that is not yet satisfactory.
The reaction of returns
The market reaction is also evident in government bond yields, which rose slightly compared to the eve of the previous meeting of the Federal Open Market Committee (FOMC), especially in the medium-term part of the curve. The markets therefore seem to be focusing on a medium-term overheating phase, followed in any case by a return to the target. In short, the credibility of the Fed is still intact.