The Federal Open Market Committee is now widely expected to agree on an accelerated timetable for reducing its bond purchases at its meeting this week, and Fed Chairman Jerome Powell may provide some hints about interest-rate hikes next year. Investors will also be focused on the quarterly update of economic projections released after the meeting.
Friday’s news that the consumer price index rose 6.8% in November—its highest year-on-year jump in 39 years—is adding to the pressure on policymakers to do something about inflation that is no longer seen as transitory.
Fear Of Economic Hard Landing Escalates; Rate Sensitivity Rises
The Financial Times, a reliable echo chamber for establishment thinking, blared a headline on Saturday that moderate Democrats are pushing the Fed for tougher action on inflation as concern grows that President Joe Biden’s party will be punished for higher prices by voters in next year’s midterm elections.
Jake Auchincloss, a Massachusetts Democrat on the House Financial Services Committee, told the British newspaper:
“The Fed needs to start tapering immediately and then they need to raise interest rates. Both those things can be done by March.”
At Republican request, the nonpartisan Congressional Budget Office produced a revised version of the deficit impact of Biden’s $1.9 trillion social spending legislation on the assumption that programs theoretically scheduled to expire would be extended. The revision showed a deficit increase of $3 trillion over 10 years, instead of the $367 billion added deficit forecast for the bill as written.
Senator Joe Manchin was the one who raised the alarm about budget gimmicks like the sunset provisions that understated the true cost of the bill. The West Virginia Democrat is not likely to be reassured by the CBO forecast or Friday’s CPI news.
The White House, which found even the original forecast too high after claiming there would be zero cost, quickly labeled the revised forecast as bogus.
The worry for investors is that the economy is in for a hard landing if the Fed has to hike rates dramatically to dampen inflation. “They are in a difficult position,” Harvard economist Jeremy Stein, who was on the Fed’s board of governors from 2012 to 2014, says of policymakers. Bloomberg quoted him as saying, if:
“they really have to hike rates significantly, you can imagine what happens to asset valuations: There’s just a tremendous amount of interest-rate sensitivity in markets.”
The European Central Bank is also holding its policy meeting this week. ECB President Christine Lagarde has already said the eurozone central bank will end its emergency bond-buying program on schedule at the end of March and she seems unfazed by rising inflation.
Jacques de Larosière, the former managing director of the International Monetary Fund who was governor of the French central bank before it became tied to ECB monetary policy, has been warning about the need for central bank action for months.
“Decision-makers and commentators who claim that the spike in inflation is transitory are making a mistake,” he wrote again last week. He and co-author David Marsh, chairman of the Official Monetary and Financial Institutions Forum think tank, cautioned that central bankers should avoid “pre-emptive pronouncements forecasting future abatement of price pressures.” Instead, policymakers should reassure investors that they will tackle the matter in keeping with their commitment to stable prices.
The authors were addressing ECB governing council members ahead of this week’s policy meeting, and they held up the Fed as a role model for making a clear shift to tightening monetary policy. The ECB has not heeded this warning in the past and it remains to be seen if the council is waking up to the inflation risk.
Awaiting Further Biden Nominations
Meanwhile, Biden has still to announce nominations for three positions on the Fed’s board of governors, originally promised for early December after he nominated Powell for a second term and Governor Lael Brainard as vice chairman.
New names in the rumor mill are somewhat more mainstream after the liberal nominee for Comptroller of the Currency, Saule Omarova, withdrew from consideration in the face of opposition from both parties.
While Richard Cordray, the first head of the Consumer Financial Protection Bureau, is likely to be named to succeed Randal Quarles as vice chairman for regulation, deputy Treasury secretary and former Fed governor Sarah Bloom Raskin and Atlanta Fed chief Raphael Bostic are now tipped for board seats, along with more progressive choices.
Senator Sherrod Brown, chairman of the Banking Committee, has indicated confirmation hearings on all five appointments probably won’t be held until January.