The Fed’s Great Experiment Now In Progress

It’s not often that the head of the world’s most important central bank recognizes that inflation is heating up while promising not to do much about it anytime soon. But that’s yesterday’s message from Federal Reserve Chairman Jerome Powell, who reaffirmed a policy of keeping interest rates lower for longer even as inflation expectations rebound.

“We do expect that as the economy reopens and hopefully picks up, we’ll see inflation move up,” Powell said on Thursday. He qualified the comment by explaining that inflation remains low and below the Fed’s 2% target. The central bank’s tolerance for reflation, in other words, remains high for the foreseeable future.

Driving the point home, Powell also reaffirmed that there are no plans to raise interest rates. Raising interest rates, he added, would require the economy a return to full employment and inflation reviving to a sustainable level above 2%. Neither on the agenda for Fed expectations this year, he explained.

“There’s just a lot of ground to cover before we get to that,” he said. Even if the economy experiences “transitory increases in inflation … I expect that we will be patient.”

 

Markets, however, seem to be anything but these days. After Powell spoke, the 10-year Treasury yield rebounded, closing yesterday (Mar. 4) at 1.54%, which matches the previous week’s peak—the highest rate in over a year.

The counterpoint is that the backup in yield is reflation rather than a return of worrisome inflation. The disinflation/deflation run triggered by the pandemic is fading as the economy heals, vaccines are distributed and the general mayhem unleashed by the coronavirus crisis gradually wanes. This rebound looks stark vs. last year’s darkest point, but it’s a return to levels that preceded the onset of the coronavirus crisis.

The revival of pricing pressure, in other words, is part of the healing process in the economy. True, but the sudden change is nonetheless striking. Prices paid in the services sector, for example, have shot up recently, based on the ISM Non-Manufacturing Index survey data. Although business activity slowed in February in this crucial slice of the US economy, prices paid by companies for inputs surged to the highest pace in nearly 12-plus years.

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Disclosures: None.

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