The FED insists it will continue to raise interest rates until it reaches 5.1% at the end of 2023. That’s a larger overall increase than it predicted in September. In fact, he believes that even then the de-escalation will be slow and the key interest rate will fall to 4.1% only at the end of 2024.<\/p>\n\n\n\n
This is based on the way it forecasts inflation. The Fed estimates in the main forecast that structural inflation will reach 3.5% in 2023, instead of the previous estimate that it had made that it would be 3.1%. Accordingly, it predicts that the unemployment rate in 2023 will reach 4.6%, while in September the corresponding estimate was that it would reach 4.2%.<\/p>\n\n\n\n
Powell himself had set the tone in late November when he argued that on a 12-month basis a key indicator the Fed looks at, the personal consumption expenditure index, was still at 6% and that even if energy and food prices were taken out , structural inflation was still at 5% and did not appear to be abating on the horizon.<\/p>\n\n\n\n
These estimates appear to be in conflict with what the markets are currently discounting. For example, according to Barclays, the bond and derivatives markets are forecasting structural inflation, based on the Consumer Price Index, of 2.6% at the end of 2023. This equates to structural inflation of 2-2.3% based on the index of personal consumption expenditures tracked by the Fed. These are estimates that are much more proportional to the assessment that inflation will ultimately be transitory.<\/p>\n\n\n
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Why do markets and Fed forecasts diverge?<\/strong><\/p>\n\n\n\n Clearly there is a discrepancy. Markets appear to be discounting that inflation could return to the desired 2% much sooner and above all without the economy having to go into recession. On the other hand, the Fed seems to consider that a degree of recession and above all an increase in unemployment, with all the difficulties it entails, is inevitable. What is the reason for the deviation?<\/p>\n\n\n\n The main reason is the way Powell and other Fed officials see inflation as having a more permanent dynamic that is mostly related to the characteristics of the labor market.<\/p>\n\n\n\n This has to do with how the Fed “reads” inflation. And that’s because it doesn’t favor headline inflation, which is heavily influenced by fluctuations in energy, consumer durables and housing, whose prices depend on fluctuations in the supply chain that often have nothing to do with overall supply and demand. . Instead, they focus on other goods and services that are less volatile. But at the same time such goods and services tend to be labor intensive. And that means that in Fed leadership’s thinking the labor market is at the center of attention relative to inflation.<\/p>\n\n\n\n That is, regardless of trends in the prices of goods and services themselves, it is a way of thinking that considers a key factor that can lead to rising inflation is a “tight” labor market, which would lead to rising costs of work, which in turn would fuel the rise in structural inflation.<\/p>\n\n\n\n Of course, this figure has received serious criticism, including the suggestion that in general in the last inflationary cycle we do not have a rise in labor costs that follow the rise in inflation, so it can hardly be considered a key causal factor at this time of inflation is the labor market situation. Instead, factors such as problems in supply chains and the faster efforts of companies to raise prices to maintain desired levels of operating profits appear to play a more important role.<\/p>\n\n\n\n The upshot is that for Powell and the Fed’s thinking there may have been good news in October and November when inflation picked up below initial forecasts, but that good news was offset by November’s labor market data , with unemployment remaining at a record low of 3.7% and average hourly earnings rising 5.1% year-over-year in November, above the pre-pandemic level of 3%, as employers look for workers potential. For Powell, the fact that labor demand is currently greater than supply, as the labor force participation rate remains lower than in the past, is an imbalance that needs to be corrected. Essentially, the Fed fears that at some point wage increases will feed inflation, rather than simply follow it, and it reckons that even if inflation eases, which is currently the main reason there is pressure for increases wages, as long as the labor market is “tight” the pressure for wage increases will continue, so an additional factor driving inflation. Consequently, there is no other path than interest rate hikes, recessionary dynamics and above all an increase in unemployment to return to an equilibrium condition, based on the Fed’s perspective.<\/p>\n\n\n\n Added to all this is of course the fact that Powell, like the rest of the Fed leadership, feels that they did not react as early and decisively as they should have previously, when they considered the increase in inflation in 2021 to be temporary, and now prefer to move with more determination, even and if they seem to ‘overreact’. In a sense right now one could say that the Fed does not trust forecasts and would rather be accused of overreaction than irresponsible inaction.<\/p>\n\n\n\n <\/p>\n","protected":false},"excerpt":{"rendered":" The announcement of another increase in US interest rates was almost expected. That is why it caused neither surprise nor great disruption in the…<\/p>\n","protected":false},"author":1,"featured_media":11700,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[859,5],"tags":[61,243,877,215,70],"class_list":["post-11699","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-economics","category-economic","tag-fed","tag-inflation","tag-interest-rates","tag-us","tag-usa"],"_links":{"self":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts\/11699","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=11699"}],"version-history":[{"count":1,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts\/11699\/revisions"}],"predecessor-version":[{"id":11702,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts\/11699\/revisions\/11702"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/media\/11700"}],"wp:attachment":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=11699"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=11699"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=11699"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}