INSIGHT: US Fed steadfast on transitory view on inflation even as forecasts rise for 2021

Author: Joseph Chang


NEW YORK (ICIS)--The US Federal Reserve is digging in on its view that high inflation levels are transitory as they are related to the reopening of the economy or due to idiosyncratic factors, even as overall inflation expectations for 2021 rise.

The Fed raised its inflation forecast based on the PCE (personal consumption expenditures) price index for 2021 to 3.4%, up a full percentage point from its estimate back in March. However, it sees inflation falling significantly to 2.1% in 2022 and rising slightly to 2.2% in 2023.

The Fed seeks to achieve maximum employment and inflation at the rate of 2% over the long run. With inflation having run persistently below this goal for many years, it said it will aim to achieve inflation moderately above 2% for some time until inflation averages 2% over time.

“Inflation has come in above expectations over the last few months but if you look behind the headline numbers, you’ll see that the incoming data are consistent with the view that the prices that are driving that higher inflation are from categories that are being directly affected by the recovery from the pandemic and the reopening of the economy,” said Fed Chairman Jerome Powell at the Federal Open Market Committee (FOMC) press conference on Wednesday.

He pointed to soaring lumber prices, which have started coming down, along with rising prices for used cars, which accounted for over a third of the month-on-month core CPI (consumer price index) gain of 0.6% in May. The core CPI was up 3.8% year on year, the highest since 1992.

The Fed chairman largely sees commodity price spikes such as in lumber as temporary. US chemicals prices also spiked after the US winter storm in mid-February, but have also come down significantly from their highs.

An ICIS index of US spot petrochemicals prices shows a 41% decline from its high in late February as plants restarted and supply constraints eased. However, prices remain elevated from both 2020 and pre-pandemic 2019 levels.

Downstream, companies continue to announce price increases. US-based specialty chemicals producer Ashland announced a wide-ranging 5% price hike for products in several markets, citing unprecedented increases in costs for raw materials, labour, transportation and logistics.

The Fed also sees the spike in used car prices as temporary. Used car and truck prices surged 7.3% in May from April, and were up 29.7% from a year ago.

“Used car prices are going up because of a perfect storm of very strong demand and limited supply – it’s going up at just an amazing annual rate. But we do think it would make sense that that would stop and in fact reverse over time,” said Powell.

“Over time, it seems likely that these very specific things that are driving up inflation will be temporary,” he added.

He also cited prices for airline tickets and hotels, which drove up the CPI reading. These prices should move up to where they were pre-pandemic, but not much further beyond, he said.

The Fed chairman also sees labour supply rising through the year as factors limiting workforce participation such as fears of Covid, lack of child care amid school closures and the expiration of enhanced unemployment insurance abate.

The Fed kept the benchmark federal funds rate unchanged at 0-0.25%, but the so-called “dot plot”, where FOMC members individually project rate expectations, pointed to two rate hikes in 2023 versus March expectations of no hike until at least 2024.

Powell stressed that these "dots" are individual projections, not indicative of policy and not a great forecaster of actual interest rate moves, and thus should be taken with a “big grain of salt”.

“We did not actually have a discussion of whether liftoff [in rates] is appropriate in any particular year because discussing liftoff now would be highly premature – it wouldn’t make any sense,” said Powell.

“The main message I would take away from the SEP [summary of economic projections] is that many participants are more comfortable that the economic conditions in the committee’s forward guidance will be met somewhat sooner than previously anticipated,” he added.

Aside from inflation, the other hot button topic is when the Fed might start to taper down its $120bn in monthly asset purchases, namely $80bn in Treasurys and $40bn in agency mortgage backed securities.

“You can think of this meeting that we had as the ‘talking about talking about’ meeting,” said Powell, referring to its plan to eventually taper down asset purchases.

No timing was provided on when the Fed would even announce such a move. However, Powell said the signalling would be “orderly, methodical and transparent” with plenty of advanced notice before announcing a decision to taper.

All this signals that interest rate hikes are a long way ahead. The playbook for now is that the Fed will first give notice on tapering asset purchases, then taper and then signal on future rate hikes.

Only if inflation accelerates or persists at an alarming rate would the Fed step in with policy tools, he indicated.

Additional reporting by Janet Miranda

Insight article by Joseph Chang