Inflation + Stalling Economy

Dear Rich Lifer,

July’s Federal Open Market Committee meeting concluded on Wednesday with the Fed announcing that current monetary policy would remain unchanged.

The only change that was made to current policy was to establish two standing repo facilities (one for domestic markets and the other for foreign and international authorities) for banks to exchange bonds for cash. 

At the same time, the committee expressed optimism that the economy has “continued to strengthen.”

Yet, Chairman Jerome Powell clearly believes it hasn’t strengthened enough to consider rate increases or bond tapering. At a virtual news conference, he stated, “Our approach here has been to be as transparent as we can. We have not reached substantial further progress yet. We see ourselves having some ground to cover to get there.”

Since 2020, the Fed has maintained that policy will not change until “substantial further progress” is made toward a 2% target inflation rate and maximum employment. 

Despite a slight uptick in volatility this week, markets have been complacent. The general consensus is we’re still in a “Goldilocks” moment, when the economy isn’t heating up too fast to make inflation a longer-term concern. So the Fed can just keep on keeping on…

But we’re not in Kansas anymore, folks. This is a brave new world where the economic outlook is uncertain due to the Delta variant of the coronavirus, and no one knows exactly how inflation will play out. 

Here’s what you need to know…

What About Inflation? 

Many experts continue to point to high inflation rates as a good enough reason to begin tightening policy. Despite the 5.4% inflation rate, Powell held firm in his belief that the current inflation is transitory. 

When questioned repeatedly about the inflation rate, he stated, “we won’t have an extended period of high inflation” and explained that transitory means “something that doesn’t leave a permanent mark on inflation.”

Fed officials have insisted that prices will stop rising when supply bottlenecks ease, demand returns to normal levels, and hot-commodities (like cars and homes) increase supply. 

Delta Variant Causes Concern

Many watched this announcement particularly close because of the recent increase in Coronavirus cases due to the highly contagious Delta variant. 

Despite the dramatic increase in Covid cases, The Fed seemed calm about the potential economic impact. Powell stated:

What we’ve seen is with successive waves of Covid over the past year and some months now, there has tended to be less in the way of economic implications from each wave. We will see if that is the case from the delta variety.

He also noted that we have “learned to live with [Covid-19].” 

While some might take this as a vote of confidence in the economy, others use the blase tone to point out that there’s no reason for continuing current policies. 

Diane Swonk, chief economist at accounting firm Grant Thornton, is in this camp, and she expressed her opinion that “at the moment, you still could argue that as we learn to live with this virus, you should be able to do tapering by year-end.”

Some politicians are increasingly pointing out that the spike in coronavirus cases can only be blamed on the unvaccinated and that because only 49.5% of Americans are fully vaccinated, we will continue to see spikes. 

While Powell is hopeful that the economic implications of further strains will not affect the economy the way it did last year, other economists worry that reimposed restrictions and consumer cautions could hurt business and overall growth.

Future Expectations

It didn’t seem to come as a shock to experts that policy remained steady. In fact, CME’s FedWatch tool showed that there was a 100% probability that current policy would not be altered. 

However, it did signal for some that tapering, specifically of bond purchasing, could be on the way. PNC chief economist Gus Faucher is one such believer, and he commented, “The Fed has started the tapering clock.”

Charlie Ripley, senior investment strategist for Allianz Investment Management, also expressed optimism after the meeting, stating, “At the end of the day, there [is] still quite a bit of uncertainty around the Fed’s action plan, but today’s outcome is further progress in the right direction.”

According to the same FedWatch tool, the likelihood of a 2022 rate increase rose from 54.4% before the meeting to 62% afterward. 

Investors are watching closely for signs of a more clear timeline for bond tapering. 

Some Fed officials have said they would consider scaling back the $40 billion of mortgage securities purchases first because of fear of another housing bubble (if you missed our piece yesterday, we go into much more detail about this). 

Powell has not confirmed this theory and on Wednesday stated that there is no expectation to reduce one type of security purchasing before another. 

Nathan Sheets, a former Fed economist who is now at investment-advisory firm PGIM Fixed Income, says it’s hard to tell for sure when tapering will officially begin because “Powell held his cards very close to his vest.”

GDP Misses the Mark

Meanwhile, second-quarter GDP numbers were released this morning and failed to hit expert estimates. 

Economists expected 8.4% annualized growth for the April-to-June period. However, the actual number came in at 6.5%. This is still an increase from earlier in the year and does push the economy’s size ahead of its pre-pandemic levels. 

Jay Bryson, chief economist at Wells Fargo Corporate and Investment Bank, remarked, “The economy has come roaring back faster than people expected.”

However, the smaller-than-expected growth signals to many that economic growth may have peaked and is now preparing to cool off as stimulus fades and the initial effects of reopening begin to lose their luster.  

Paul Donovan, the chief economist at UBS Global Wealth Management, held no opinions back when he stated, “For the first time in decades, we have a Fed chair who is not an economist. Markets may have expected too much, especially as the Fed is divided on policy.”

Despite the slightly disappointing numbers, the stock market seemed largely unaffected. The Dow Jones Industrial Average rose 0.6%, the S&P 500 increased 0.4%, and Nasdaq Composite ticked 0.2% higher.

The markets may have been more focused on the announcement from a bipartisan group of Senators who finally announced an agreement on a $1 trillion infrastructure spending plan, which the Senate then voted to begin drafting. 

For now, tapering is still on hold while we wait for the Fed’s next meeting on September 21 and 22.

To a Richer Life,

The Rich Life Roadmap Team 


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