What Transitory Inflation Means For Markets

Jerome Powell’s “Transitory” Clarification

Jerome Powell, Federal Reserve Chairman, has been renominated by President Biden, opting for stability in the central bank’s leadership. In tumultuous economic times, the administration is looking for a straightforward confirmation process in the senate, instead focusing its whipping efforts on more progressive campaigns. Support has risen from both sides of the aisle, with the senior Senate Banking Committee members Sens. Sherrod Brown and Pat Toomey, Democrat and Republican respectively, voicing their affirmation. A newly reconfirmed and emboldened Jay Powell will take a more vocal and active role to carry out the Fed’s mandate in the months to come.

The Federal Reserve & Inflation

The core function of the Federal Reserve is a dual mandate to maintain price stability and full employment. Mr. Powell, who has overseen the Fed since his nomination to the position by President Trump, has highlighted the importance of keeping rates low, buying trillions of dollars of government notes and other assets to stabilize credit markets from a freefall. This policy, along with trillions of dollars in fiscal relief spending, has fueled an increase in consumer prices beyond the traditional 2% year-over-year inflation target. The Federal Reserve Bank had previously said that they intended to allow the economy to run hotter for longer, stabilizing years of below-target inflation and boosting employment back toward pre-pandemic levels. As prices continued to rise, Jerome Powell maintained that this inflation was “transitory,” blaming the supply chain crunch and short-term demand tailwinds for rising consumer prices. One of the Federal Reserve’s chosen inflation metrics, the consumer price index, rose 6.8% year-over-year in the month of November.

Rising inflation is not necessarily worrying on its face, as a healthy, growing economy requires some level of persistent inflation to function; however, as wages fail to keep up over the long run the real value of the dollar declines and consumer confidence sentiment dissipates. Finding the delicate balance between full employment (different from 100% employment) and inflation maintenance is an evergreen responsibility. With unemployment reaching a pandemic-record-low of 4.2%, the Fed has the responsibility to begin turning off the tap.

The Tides Appear To Be Turning

At a recent senate hearing, Mr. Powell admitted that the description “transitory” has misled some to the inflation condition and that it was time to sunset its use. He went on to note that some understood its use to mean “short-lived,” a perfectly reasonable interpretation. The Fed meant that it would not “leave a permanent mark in the form of higher inflation.” Permanent or not, consumers are feeling the pain of higher prices and are looking to the Federal Reserve to enact policy changes.

In the same hearing, Powell indicated that the central bank was considering a faster taper of their ongoing bond-buying program. They had previously signaled that they would reduce their $120 billion monthly purchase program by $15 billion each month, effectively ending the program in mid-2022.

Now it seems that inflationary pressures will prompt the Fed to end the program even sooner. Starting in January, asset purchases will be reduced by $30 billion per month – double the previously targeted $15 billion per month. The market, already in turmoil over COVID-19 variant Omicron fears, has responded negatively in recent weeks when faced with the potential for a more hawkish stance at the Fed. The conclusion of the Fed’s tapering program is expected to be followed by an uptick in the fed funds rate, ultimately increasing the cost of borrowing. This may cool the economy as home buying and business investment slow in response. Given higher interest rates, discount rates should experience upward pressure, which may prompt money to flow from more speculative investments into more secure instruments, like bonds. Any increased speed or urgency of the tapering program and rate hike outlook will have to be priced into the equity markets.

The Blue Chip Perspective

While it is uncertain what the ultimate result of these market shifts will be, it is unquestioned that Fed policy changes and any sort of continued COVID variant concerns will stir up markets into 2022. Over the long term, these changes will stabilize inflation and continue to project economic strength as rebuilding occurs.

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