The Recent Inflation Surge Still Appears To Be Peaking

Federal Reserve Chairman Jerome Powell admitted in yesterday’s press conference that if inflation runs hotter for longer than it expects, the central bank would react accordingly by adopting a more hawkish stance. But for now, that scenario remains a low-probability scenario, he says.

“Our expectation is that these high inflation readings that we’re seeing now will start to abate,” Powell said. If that outlook turns out to be wrong, he insists that the Fed is prepared to tighten monetary policy.

“There’s a lot of uncertainty,” Powell admitted, and if the hard data on inflation or inflation expectations continue to run hot, “we wouldn’t hesitate to use our tools to address that.”

Signs that the policy is already reacting to the recent increase in inflation data showed up in the Fed’s revised economic forecasts. Notably, the central bank’s estimate for core PCE inflation in 2021 shot up to 3.0% from 2.2% in the March projection. That may be a tame move by some accounts, but it’s a large adjustment for the Fed in the time frame of just one meeting. It’s also a sign of the times in terms of volatility and uncertainty in economic estimates.

The Fed hasn’t given up on its inflation-is-transitory guidance. After this year’s expected increase, the central bank’s estimates for core PCE inflation falls back 2.1% for 2022 and 2023, which is roughly in line with the Fed’s inflation target. That may be wishful thinking, but it’s a reminder that policymakers continue to assume that a regime change in inflation to the upside is still unlikely.

Nonetheless, the Fed pulled forward its expectations for rate hikes to as soon as 2023 vs. 2024 in the March outlook.  

“This is not what the market expected,” says James McCann, deputy chief economist at Aberdeen Standard Investments. “The Fed is now signaling that rates will need to rise sooner and faster, with their forecast suggesting two hikes in 2023. This change in stance jars a little with the Fed’s recent claims that the recent spike in inflation is temporary.”

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Disclosures: None.

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