What is transient? Federal Reserve Chairman Jerome Powell admitted on Tuesday that it is not inflation, saying the central bank is likely to consider accelerating the downsizing of its bond purchases at its next political meeting on 14-15. December.
What may prove to be more transient is the effect of the Omicron variant of the Covid-19 virus. Yet its effect on the pandemic and the economy is unknown. Given that economic growth was only temporarily halted by increases in the Delta variant, it is too early to expect that Omicron will require a worse toll.
IN his prepared remarks to the Senate Banking, Housing, and City Committee, released Monday, Powell allowed Omicron to pose a risk to the Fed’s dual mandates on inflation and employment. With regard to the former, the central bank’s target of bringing inflation above its previous 2% target for a longer period has been met, with its preferred target (the core deflator for personal spending) up to 4.1% year-on-year. . Supply chain effects already seen to diminish may return if the pandemic worsens.
As far as the labor market is concerned, the question is, how close is it to full employment? Concerns about Covid appear to prevent many people from returning to the workforce, Powell noted, along with Treasury Secretary Janet Yellen, who also testified before the panel.
Given the widespread reports of more job openings than job seekers, it may fit the description of full employment. The latest indication came on Tuesday from the Conference Board, whose consumer confidence survey showed that the so-called labor market gap – the spread between respondents who considered jobs easy to get, versus those who thought they were hard to find – rose to record highs in November. If Omicron further slows down the supply of workers, all other things being equal, the labor market could become tighter.
Powell indicated to the Senate panel that the FOMC could consider winding up its asset purchases “perhaps a few months earlier” than currently expected. As announced earlier this month, the Fed made its initial cut of $ 15 billion, lowering its monthly purchases to $ 105 billion from $ 120 billion previously. Powell stressed that these acquisitions of central bank assets, although smaller, continue to add liquidity to the financial system.
The completion of its bond purchase is a prerequisite for the Fed to begin raising its interest rate target from the current ground-breaking range of 0-0.25%. According to Powell, the Fed Funds futures market went back to discounting at least two 15 basis point rate hikes before December 2022, according to CME FedWatch. (A base point is 1/100 of a percentage point.)
The message of less accommodating financial conditions was clear from Tuesday’s market action, especially in equities. The Dow Jones Industrial Average and the S&P 500 ended the day with a fall of about 2%, while the Nasdaq Composite fell 1.6%. This was despite a jump of 2.8%
(ticker: AAPL), the largest component of the S&P 500 and Nasdaq, limiting their losses.
The financial market gave an even more direct indication of expected interest rate hikes from the Fed next year. The yield curve flattened radically, with the two-year bond yield rising 4.3 basis points to 0.531% in the middle of the afternoon, while the 10-year yield fell 5.4 basis points to 1.445%. As a result, the spread between the two- and 10-year bonds narrowed to 91.4 basis points, a nine-month low, according to St. Louis Fed. However, there is still a positive fall in the yield curve, which supports the economic conditions, although not as super-stimulating as earlier this year.
A seemingly confusing aspect has been the recent weakness in the dollar. The US Dollar Index (DXY) fell 0.3% in the middle of the afternoon on Tuesday, the opposite of the expected response of the foreign exchange market to expectations of higher short-term interest rates developed by the Fed. Market sentiment has been strongly bullish on the dollar, resulting in a 6.7% increase in DXY since the middle of the year. So the dollar action can be more technical than fundamental.
Powell stressed in his testimony Tuesday that the FOMC will have new readings on employment and inflation before the next meeting in a few weeks. The key will be the November job report released Friday morning, which economists predict would show a robust increase in the non-agricultural payroll of 500,000 or more, plus a fall in unemployment from October’s 4.6%.
But only a shockingly weaker report would likely deter the FOMC from carrying out the faster downsizing that Powell tipped on Tuesday, which had also been discussed recently by other Fed officials, particularly Vice President Richard Clarida. Or a serious deterioration in Omicron, which is not clear now. “Given the consistency of the Fed’s announcement in recent weeks, it now appears that it will take a worsening of the public health situation over the next two weeks to prevent the FOMC from deciding to increase the pace of the downsizing at the next meeting, ”writes Michael Feroli, JP Morgan’s US chief economist in a customer note on Tuesday.
The markets heard the message loud and clear.
Write to Randall W. Forsyth at email@example.com
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