Omicron and inflation have left Wall Street on edge in recent days, and investors are anxious about how the Federal Reserve will lay out its plan to navigate these twin economic threats as policymakers wrap up their final meeting of the year on Wednesday.
Data released last week found that consumer inflation hit a four-decade high, and the Department of Labor reported Tuesday that wholesale prices jumped at a record rate of 9.6 percent from a year ago.
“I think it’s the impact on the broader population that’s really the Fed’s challenge,” said Stephen Lee, principal of Logan Capital Management.
In recent comments, Fed Chairman Jerome Powell, who was renominated last month to lead the Fed for another four years, has retreated from describing price increases as “transitory.” There is widespread expectation that he will use his Wednesday afternoon press conference to announce that the Fed will wrap up its pandemic-era bond-buying program more quickly than it initially planned.
“I’m expecting a substantially more hawkish tone heading into Wednesday,” said David Wagner, portfolio manager and analyst at Aptus Capital Advisors. “Inflation is real right now.”
For the past year and a half, the Fed has bought $80 billion in Treasuries and $40 billion in mortgage-backed securities, part of a strategy to stabilize the financial system when it was feared that global shutdowns resulting from Covid-19 could trigger an economic collapse. The Fed initially advanced a six-month timeframe for the wind-down, but there are indications that it might adopt a faster pace, possibly concluding in March rather than in June.
A speedier wind-down likely points to earlier rate hikes, action on which market expectations have changed considerably in recent months: As recently as March, the Fed wasn’t expected to raise its benchmark rate from its current near-zero level until 2024. Now, those same projections call for as many as three quarter-percent rate hikes in 2022 alone, implying a Fed funds rate of between 0.75 and 1 percent.
Current projections call for as many as three rate hikes in 2022.
“I think the markets are predicting that the Fed’s hands will be forced to raise rates earlier and faster than previously expected,” said Dan North, senior economist at Euler Hermes North America.
“This is just a reaction from the Fed as they’ve seen this trade off between growth and inflation worsen. They’re forced into difficult decisions,” said James McCann, deputy chief economist at Abrdn, because of the unique distortions the pandemic has imposed on the economy.
Policymakers have offset previous macroeconomic shocks in the past by increasing the money supply and adopting more accommodative positions, but that playbook isn’t a go-to this time around. The Fed can’t do anything about factory shutdowns in Asia or container ships queued up off the coast of California, said Ross Mayfield, investment strategy analyst at Baird.
“A lot of the inflationary pressures are on the supply side of the equation, which the Fed can’t do much about,” he said.
Dysfunction in D.C. also doesn’t help. “You’ve got policy uncertainty as well as Covid uncertainty. It really makes the Fed’s job a little more challenging,” Lee said, pointing to the ongoing wrangling in Washington.
Some lawmakers, primarily but not exclusively Republicans, have criticized President Biden’s Build Back Better economic agenda, saying that the roughly $1.7 trillion package would contribute to inflation by pouring more money into an economy that already shows signs of overheating and as well as putting more pressure on already-strained supply chains, which could exacerbate the climbing costs for a growing list of goods and services.
Different studies have produced a variety of conclusions, and analysts likewise are split on the likely impact — particularly given the uncertainty around the extent and duration of supply-chain issues moving into the new year.
Ethan Harris, head of global economics research for Bank of America, warned in a new report that adding demand in an economy already facing tight supplies of both materials and labor could drive prices up further. “In our opinion, the proposed increases in investment would stimulate demand more than supply in the short run, creating inflationary risks,” he wrote, although he noted that the ultimate impact could differ depending on what the final legislation includes.
Harris also called the Build Back Better Act “quite progressive in the short run,” though. He noted that lower-income families would benefit from multiple new tax credits — which would achieve a key goal of the platform advanced by Biden’s economic team.
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