As Inflation Soars, The Fed Needs To Keep Its Head – ValueWalk Premium

As Inflation Soars, The Fed Needs To Keep Its Head

So much for transitory. U.S. prices rose by 7% in 2021, the highest gain for nearly 40 years. Remember: The Federal Reserve’s target for inflation is 2%, a fact that gets less attention than it used to, back when “hawks” and “doves” were measuring deviations in tenths of a percentage point. It’s an enormous overshoot, and some of it is likely to prove persistent without corrective action.

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The good news is that the Fed can no longer be accused of playing down the risks. In the past two months, its policy stance has moved briskly from patience to concern, with a hint of alarm. Chair Jerome Powell told lawmakers this week that he regarded inflation as a “severe threat.” So far, to its credit, the central bank has accomplished this abrupt shift in messaging without roiling financial markets. Investors expect the Fed’s bond-buying program to be promptly wound down and have calmly penciled in four increases in interest rates this year, starting in March.

Will this accelerated timetable be enough? It looks about right — but with the pandemic far from contained and new uncertainties surrounding the omicron variant, it’s impossible to be sure. The Fed needs to keep an open mind, and stay ready to tighten or loosen policy as conditions evolve.

The reasons for the surge in prices are plain enough. Unprecedented supply-chain disturbances have throttled output while equally unprecedented fiscal and monetary stimulus turned demand up to max. Looking ahead, fiscal policy is likely to be much less aggressive. (Supposing President Joe Biden’s stalled Build Back Better plan eventually passes, it would likely involve only a modest further stimulus.) And monetary accommodation is slowly being withdrawn. Even bearing in mind that an inflation spike has the effect of loosening monetary policy (by lowering the real rate of interest), the Fed is no longer deliberately spurring demand.

Read the full article here by The Editors, Advisor Perspectives

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