Jay Powell looks past the Omicron threat in the hawkish axis on inflation

With financial markets already selling off on concerns about the Omicron coronavirus variant, it seemed a strange moment for the Federal Reserve chair to deliver his most hawkish comments on policy. currency since the pandemic began.

But on Tuesday, Jay Powell effectively removed The Fed’s previous stance on soaring inflation and signaling support for a faster cut in the central bank’s massive bond-buying program gives policymakers a chance to raise interest rates quickly. than expected.

In doing so, Powell sent a clear message to markets: fight inflation, fight a 30-year high last month, now a priority for a central bank that has spent nearly two years focusing on boosting demand and jobs.

“Inflation has come ahead of their plans,” said Kathy Bostjancic, chief US financial economist at Oxford Economics. “This was something they didn’t anticipate and now they need to pivot and adjust their policies to achieve their goals.”

During two days of testifying before Congress this week, Powell made a brief admission of the emergence of the Omicron variant, which he described as a potential risk to economic growth that had not been “given into” the Fed forecasts. But he spent much of his time promising to tackle what he describes as “persistently higher inflation.”

Powell warned that price pressures previously concentrated only in certain corners of the economy have expanded. And he dropped the use of the word “transient,” to which the Fed stuck throughout the year because it asserted the rise in inflation was primarily tied to temporary supply chain disruptions.

By far the clearest sign that Powell is determined not to let inflation become “entrenched” is his revelation that he will be very supportive. faster “Cut down” on the bank’s bond-buying program, with the full withdrawal of stimulus “probably a few months earlier” than planned.

Even with about 4.2 million more people out of work than at the start of the pandemic, and despite the threat from Omicron, the need to stimulate the economy has “clearly diminished,” Powell told the committee. Senate Banking Committee on Tuesday. He stuck with the same scenario in another hearing on Wednesday.

“This is a very abrupt turnaround from the Fed: the eight-month reduction plan was announced only four weeks ago and the New York Fed,” said Krishna Guha, a former Fed employee who is now a vice president at Evercore ISI. just started doing it. it was two weeks ago. ”

Guha added that the sudden change in tone would “promote the feeling” that there is a “much higher chance” that the Fed makes a “step change” in its rate plan.

Line chart of two-year US Treasury yields,% showing Powell's policy axes

NS notification that the Fed will begin cutting its $120 billion-a-month asset purchase program in early November, after months of pondering over the underlying strength of the recovery. It also marks the beginning of an end to emergency measures taken at the start of the pandemic to avert economic catastrophe.

The Fed initially said it would scale back purchases by $15 billion per month, meaning the program would end in June 2022, stressing that it would be flexible based on economic conditions.

But economists at Barclays this week said they now expect the Fed to accelerate at its January meeting for the stimulus program to end in April. That would pave the way for a rate hike a month later, Barclays added, expecting two more rate hikes in 2022, followed by four more in 2023.

“What’s happening here is that Powell is looking at the level of inflation and how fast the economy is growing and is starting to worry that the Fed has been too lenient for a long time,” said Tim Duy, an expert Economics at SGH Macro Advisors and the University of Oregon. “They’re changing the story.”

Financial markets reacted furiously to Powell’s comments this week because an earlier end of the asset buying program could mean interest rate hikes much sooner than anticipated.

U.S. stocks fell sharply on Tuesday and yields on two-year Treasury bills – the most sensitive to monetary policy adjustments – jumped to 0.6%, hovering as low as 0.44 % earlier in the trading day. It is currently at 0.55%.

However, some Fed watchers don’t believe the Fed will abandon its long-time cautious approach so quickly, especially given the enormous uncertainty surrounding the new variant.

Roberto Perli, who previously worked at the Fed and now leads the global policy team at Cornerstone Macro, analyzed Powell’s use of the word “consider” this week when discussing cuts plans. Fed and central bank president stressed that officials will be closely monitoring the data.

“If the Fed [sped] if incremental, it runs the risk of sending out a panic message or admitting that it made a mistake a month ago,” Perli said.

Eric Stein, chief investment officer of fixed income at Eaton Vance, agrees that tightening financial conditions could prompt the Fed to return to its patient approach. But there will be a significant downside due to how “strong and emergent” the risk market is, he added.

But for everyone else, this was the week where Powell made a much-needed pivot, transforming himself from a soft dove into a hawk and deciding to take on inflation more aggressively.

“The economy can absolutely handle slightly higher interest rates,” said Constance Hunter, chief economist at KPMG. “This shift in stance is consistent with economic data and consistent with maintaining [the Fed’s] trust so that inflation does not get out of control”.

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