A New Era For Fed Policy… And Inflation?

Inflation is mounting a comeback. Not as an imminent macro threat, at least not yet. But as a topical subject for monetary policy and a relevant factor for looking ahead in economic and investment terms, the subject of inflation will likely resonate on a deeper level going forward. The source of this shift, of course, is the Federal Reserve, which is winding down its great experiment in monetary stimulus and laying the groundwork for reviving something approximating a “normal” policy regime.

The latest smoking gun was outlined in yesterday’s release of the Fed’s FOMC Minutes for last month’s meeting: “If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting.” Although the guidance in that sentence wasn’t unexpected, what’s different is that the central bank is now publicly discussing explicit dates as opposed to vague references about the future. A minor change? Perhaps, although one can persuasively argue that the shift marks a new stage in the Fed’s game plan in the post-2008 world.

Nothing’s written in stone, of course, even when the Fed cites specific dates. But barring a sudden and expected deterioration in the economic trend, which looks unlikely based on the latest data, we’re formally in the end game. Quantitative easing (QE), which was unveiled in its first incarnation in 2009, is headed for the history books, and it leaves a mixed legacy. The first question for the new era: When will the Fed start raising interest rates? That’s a ways off, expected to start sometime next year, or just after the new year. Depending on the forecast, the first increase in Fed funds will start as early as mid-2015 or as late as early 2016. In any case, no one should confuse the end of QE with higher rates. The former leads to the latter, eventually, but the two aspects of policy are different animals in terms of timing.

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