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Omicron is the obvious elephant in the room these days, but we can’t lose sight of the impact of changes in Federal Reserve policy taking place. After over a decade of very easy monetary policy designed to at first help the economy recover from the global financial crisis, then to promote growth toward the Fed’s full employment mandate, and finally to come back from the pandemic induced recession of 2020.
Now suddenly confronted with increasing inflation that has proven to be less transitory than the Fed had predicted, it is the Fed’s other mandate that is taking precedence, namely price stability. The new policy involves speeding up the tapering (reduction) of the Board’s bond purchases and proposing to implement three rate increases in 2022 in an effort to rein in the rate of inflation.
However, I wonder about Chairman Powell’s commitment to said policy after hearing his answers to some of the questions posed at his press conference. In particular he said “In dealing with balance sheet issues, we’ve learned that it’s best to take a careful, sort of methodical approach to making adjustments. Markets can be sensitive to it and we thought this was – this was a doubling of the speed….”. While somewhat convoluted in speech, I am convinced he remains worried about the effect of policy on financial markets.
Put more simply, he is fully prepared to reverse course and step back on the gas if there is a significant market decline and Omicron only adds to that possibility. Fed credibility has already come into question and such an outcome won’t help.
For now investors seem to have accepted the need for some measures to control inflation, but the Board will be walking a very fine tightrope: tighten too much and risk recession and weak markets (at least until the Fed steps back in), or not tighten enough and inflation will get worse (at least until the Fed tightens even more).
The obstacles are not insurmountable and, ever the optimist, I hold out hope that inflation will ease, and such sledgehammer responses will not be required.
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By The Way - December 2021
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