Omicron more a ‘tactical’ than ‘strategic’ consideration

From

Stephen Miller

Powell pivot sees “taper tantrum” or is it “rate rise reflux”? Omicron more a “tactical” than “strategic” consideration at this point.

This year the big themes in markets when it comes to central bank policy have been continuing waves of the COVID-19 virus versus price pressures that have morphed into stubbornly persistent inflation.

That appears to be continuing.

In what should have been a statement of what Basil Fawlty might call “the bleedin’ obvious,” Chair of the Federal Reserve of the United States (the Fed), Jerome Powell, conceded that inflation was more persistent than the Fed had thought, and further suggested that it was time to “retire that word [transitory]”.

This should have been well-known for a while. After all, the most recent projection for core personal consumption expenditures (PCE) from the Fed following the September Federal Open Market Committee (FOMC) meeting just over two months ago was for an annual increase in 2021 of 3.7 per cent (upwardly revised from 3.0 per cent forecast in June and 2.2 per cent in March). 

Given that the core PCE has already increased by 3.8 per cent in the year-to-date and that recent high-frequency price indicators indicate that price pressures remain at close to multi-decade highs, it is clear that the Fed’s most recent forecast will be exceeded, with the final outcome likely close to double the Fed’s original forecast. 

Clearly inflation has been nowhere as “transitory” as the Fed projected, even if, somewhat optimistically in my view, the latest Fed forecasts have inflation returning to longer-run targets of close to 2 per cent in subsequent years. That may change when the Fed issues new forecasts on December 14-15.

Powell then went on to state that because “inflation pressures are high” the Fed will “consider wrapping up the taper of our asset purchases… perhaps a few months sooner.” Again, that should not have been a surprise given the Fed’s FOMC minutes of its November 2-3 meeting emphasised on “flexibility” in its approach to tapering. A number of Fed speakers have been saying for some time that the scheduled pace of tapering might need to be accelerated if inflation pressures are more manifest – which Powell now acknowledges be the case.

What roiled markets, however, was the notion that with the Fed contemplating an accelerated taper, markets have now switched attention to the possibility that there may be multiple rate rises in 2022. At the most recent ‘dot plot’ issued in September, nine of 18 officials forecast a move in the policy rate next year with that ‘dot plot’ (as well as the scheduled tapering) due to be revisited at the Fed’s next FOMC meeting on December 14-15. It now seems likely that a majority will now see a least one policy rate rise (and quite possibly more) in 2022.

With respect to the emergence of the Omicron variant, it might be a case of discretion being the better part of valour and the Fed might resist too large an adjustment in its current plan by the time the next FOMC meeting rolls around on December 14-15. 

At this stage, however, any delay to an acceleration of tapering plans, because of higher and more persistent inflation, might be thought of as a “tactical” move so as to obtain time to get a clearer understanding of the potential economic dislocation that arises from this most recent variant. 

Yet, economies have exhibited an extraordinary ability to bounce-back from previous waves or variants of the pandemic and there seems no reason to suppose that the current one will be any different in that respect. Recent labour market indicators remain strong. Last night’s Automatic Data Processing Inc. (ADP) employment release showed employment at  more than 534,000 for November, ahead of the payroll numbers tomorrow, while last week’s jobless claims fell to a 52-year low.

In that context, the “strategy” remains unchanged: some withdrawal of stimulus, including accelerated tapering and / or the possibility of rate rises in 2022 probably remains appropriate. What Omicron might do is see those rate rises possibly more back ended than perhaps they might otherwise have been.

Indeed, by accentuating price pressures arising from supply bottlenecks and perhaps delaying the withdrawal of historically high levels of monetary stimulus, the inflation problem might grow to be even more of a challenge for both central banks and investors in 2022. 

The big question now seems to be whether that might ultimately mean a higher destination point for the policy rate and whether the “rate rise reflux” will also prove “transitory”!

Chairman Powell’s first term was dominated clearly by the challenges of the pandemic but also by the delicate politics of managing the relationship with a mercurial CEO. 

Having survived the latter challenge and doing a competent enough job on the former, it doesn’t seem the Chairman’s second term will be any easier.

By Stephen Miller, investment strategist 

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