Fed officials generally agree that they can begin to reduce economic support policies soon, but there are still differences within the Fed regarding the threat of high inflation and what they may need to do about it, whether to be patient or to act proactively.
On Wednesday, local time (GMT+8, Thursday, October 14th, 2:00 am), the Fed will announce the minutes of the policy meeting on September 21-22, which will provide clues about the intensity of the debate. Central bank officials sent the clearest signal to date at this meeting, indicating that the crisis response policy is not long before the exit.
The US economy in 2021 is expected to record the fastest growth in decades (because the economy in 2020 is too poor), the inflation rate is much higher than the level that makes the Fed feel at ease, and the job market has basically recovered from the heavy blow caused by the new crown epidemic. In this case, most Fed officials believe that it is prudent to start reducing the $120 billion monthly bond purchase scale.
Fed Chairman Powell said last month that as long as the job market data is "good", he expects the Fed to reduce its purchases of government bonds and mortgage-backed bonds to begin next month and be completed by the middle of next year.
The US government announced last Friday (October 8) that non-agricultural jobs in September increased by only 194,000, far below analyst expectations.
Fed Vice Chairman Clarida said on Tuesday (October 12) that the threshold for reducing debt purchases has been "basically reached", but did not explicitly point out that the reduction in asset purchases will begin in November.
Clarida reiterated Powell's prediction of reducing the time to purchase debt, and the minutes of the September policy meeting may strengthen this view.
If the meeting minutes or other hints suggest that policymakers plan to speed up or slow down the rate of contraction based on the pace of economic recovery, it will mean a departure from the predictable model adopted by the Fed in 2014 and will surprise the market.
Perhaps, and more likely, the minutes of the meeting add a new color to the inflation outlook for policymakers, especially whether anyone believes that they will eventually have to sacrifice the goal of achieving full employment to prevent inflation from spiraling.
Harvard University Economics Professor Karen Dynan said last week, “I think most central bank leaders don’t think they face this trade-off at this time because they think inflation will subside. If next year... make a choice."
The economic forecast released at the same time as the Fed’s policy statement last month showed that the Fed expects the inflation rate to reach 4.2% this year, more than twice its flexible target of 2%. The latest US September CPI rose 5.4% year-on-year, and the core CPI rose 4% year-on-year.
Powell and Clarida downplayed this possibility. Clarida said on Tuesday that even though the Fed’s decision makers have almost half of the two views on whether the Fed needs to start raising interest rates next year or 2023, their estimates are “fully in line with” the Fed’s aim to maximize employment. A policy framework for globalization and inflation stabilization.
But public comments by other policymakers, including the two longest-serving regional Fed chairmen of the Federal Reserve, indicate that active discussions have taken place in private.
St. Louis Fed President Brad is worried that the current high inflation may continue and take root in the economy, requiring a "greater" response from the Fed. He is worried that inflation may remain at a high level or continue to rise, and hopes that the Fed will complete the reduction of asset purchases early next year so that it can raise interest rates in the spring or summer if necessary.
Chicago Fed President Evans believes that the supply bottleneck is the main reason for the recent increase in inflation. Although inflation is higher than initially expected and may last longer, this rapid increase will eventually subside. He advised his colleagues to "keep patience", noting that there is no need to start raising interest rates before the end of 2023.
Clarida said on Tuesday that he saw no signs of unhealthy increases in inflation due to wage increases, but the "biggest unknown" is how long the supply bottleneck that pushes up prices will last. He did not state his current expectations for interest rate hikes.
How the different views of policymakers determine the actual time for the Fed to raise interest rates is not only related to investors who are concerned about the market, but also to the majority of Americans, especially those millions of people who were still working before the epidemic but are now unemployed.
If Fed policymakers believe that they need to raise interest rates before the economy reaches full employment to stop inflation, it may shorten the time for economic recovery.
If they choose to postpone rate hikes to give the job market more opportunities to repair, but at the same time misestimate the staying power of inflation, they may have to raise interest rates substantially to make up for the loss in fighting inflation.
Tim Duy, a professor of economics at the University of Oregon, said that this is forming an "unpleasant situation," as Powell's Fed chairmanship ends in February 2022 and the uncertainty about who will lead the Fed has made the situation even more serious. US President Biden has not yet stated whether he will reappoint Powell or choose someone else to lead the Fed.
Investors need to focus on the detailed description of the inflation outlook in the minutes of the meeting. At the same time, they need to pay attention to any wording about possible changes in the scale of future bond purchases. Relatively speaking, the monetary policy meeting in September was a bit more hawkish than the market expected at that time. The minutes of the meeting may also be slightly biased towards the hawks as a whole, but we still need to beware of the possibility that the hawks fall short of expectations.
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