Wed. Dec 8th, 2021

The Federal Reserve remains in a precarious obligation against inflation, investors and analysts say.

AP / Patrick Semansky

US inflation shows signs of moderation, but not enough to decisively resolve the debate over whether the recent pace of price rises is transitory or not.

The July consumer price index report, which showed that the maximum annual rate remained at a 20.4-year high of 5.4%, leaves the Federal Reserve in a still precarious obligation. If future inflation readings are surprisingly on the rise or remain high in the coming months and into 2022, the risk is that consumer expectations on higher prices will sink deeper and be harder to reverse, according to say investors and analysts.

And, for now, the central bank is not in a position to do much about this risk other than talk about it, as its two best options for action are not on the cards for a while. For now, the Fed is focusing on whether, when and how much it needs to recoup its $ 120 billion monthly bond purchases first. Therefore, it could easily be at least a year before the central bank provides its first interest rate hike, which typically takes six to nine months to affect the economy. Meanwhile, the other option for policymakers, in addition to a rate hike, the reduction of the Fed’s balance sheet of $ 8.2 trillion, is not currently on the radar.

“One of our big concerns is for a stagflation-like environment, where there is weak growth and above-average inflation that the Fed can’t do much about,” said Alan McKnight, director of Birmingham-based Regions Bank investment, which oversees assets of more than $ 47 billion. “It’s not a base case, but that’s the risk.”

In a telephone interview, McKnight said his benchmark forecast calls for the annual CPI rate to fall by about 4% this year, accompanied by real GDP growth of 6.1%, which should fall up to 2.8% and 5.3%, respectively, in 2022 In anticipation of the risks of these prospects, he states that his company has already reduced its allocations to large-cap US equities, while it has reduced its their fixed income holdings “generally” because it is difficult to see a scenario in which good Americans do. well ”in an environment of higher inflation that leads to higher market-based rates.

Following Wednesday’s release of the print version of the CPI, long-term Treasury yields such as the 10-year TMUBMUSD10Y,
1.329%
they increased profits, leaving them near the highest levels in almost a month. Still, they remain below where they were for much of this year, which some see as a sign of an impending economic slowdown and / or bond market confidence in the Fed’s ability to control inflation. Meanwhile, equilibrium rates reflecting the point at which traders see inflation heading from five to ten years have moderated since May.

But with each passing month, “there has been a little more evidence that some components of inflation are about to continue to rise and risk factors have grown,” said Greg McBride, chief financial analyst at Bankrate.com , an online provider of information rates. “The reality is that it will start in 2022 before we know for sure if the price pressures are transitory. And right now, the Fed is behind the curve. “

Complicating the Fed’s options on the inflation front is what will likely be a months-long process, which a growing number of people inside and outside the central bank say should start soon. Many see volume downsizing as the first step toward tightening financial conditions, though strategists at JPMorgan Chase & Co., portfolio manager Federated Hermes Inc., RJ Gallo, and others, reject cold water on the idea that reducing bond purchases will only be enough to take away as much as people think.

Read: Today’s inflation figures won’t do much to slow down the conversation

“Volume reduction remains expansive, albeit at a slower pace,” said Fergus Hodgson, director of Econ Americas, an equity research firm. For the Fed, “the risk is that you make inflation expectations permanent and play with fire.”

At least one political leader, James Bullard, of the Federal Reserve Bank of Saint Louis, is pushing for a process of time reduction faster than many expect, one that begins this fall and ends in March; sees the risk that part of this year’s inflation rise will last until 2022. Meanwhile, Richard Clarida, a senior Fed official, has pointed out in early 2023 a time when the central bank could begin to raise rates, as long as the economy makes sufficient progress before then.

For now, investors say, both the Fed and bond markets are positioned to achieve an optimal outcome: one in which the transition to less central bank accommodation occurs seamlessly without jeopardizing economic growth, while that inflation goes down, over the next 12-18 months.

“Stagflation is a scary word,” says Gene Goldman, investment director and research director at Cetera Financial Group based in El Segundo, California. He says he sees the risk of something more like a “stagflation-lite,” in which inflation doesn’t necessarily rise dramatically from here, but “the Fed is behind the eighth ball.”

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