The Fed just conducted one of the most rapid and aggressive about-faces we can remember seeing since the global financial crisis. It is certainly more aggressive than the first Powell pivot of 2018/2019, when in the face of significant market weakness through the end of 2018, the Fed scaled back expectations of rate increases, but then lowered rates three times in the second half of 2019. For central bankers whose main career goal is to “make central banking boring” (as the BoE’s Mervyn King once put it), they are not doing a particularly great job of it. The reason for the shift is that we have very quickly moved into the midcycle, and both inflation and employment have come back much faster than had been expected. The Fed also wants longer-term inflationary expectations to remain well anchored, at a time when its credibility is already being tested in other areas such as trading scandals.
As highlighted by various senators in this week’s re-nomination hearings, the Fed is under much greater pressure from Main Street (and, no doubt, the Democrats ahead of the midterms) to do something about inflation.
In this Economics Weekly, we reexamine the current inflation debate, with the view that we still expect inflation to moderate over the coming year to around 2.5%-3% and then drift a little lower in 2023; however, the risks are to the upside, as service prices accelerate and less-severe COVID strains such as Omicron could continue to disrupt supply chains. In addition, with the economy in the midcycle and the labor market tight, even without already high inflation, the Fed needs to act so that second-round effects—unanchored inflationary expectations and a wage price spiral—do not appear and become entrenched.
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Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.