Powell ajar Pandora’s Box: The Challenge of Controlling Inflation Without Shaking Rates

The Fed’s announcement of two hikes in 2023 brings to the fore the dilemma of how to deal with the withdrawal of stimulus deployed with the crisis

Six days have separated the meetings of the European Central Bank (ECB) and the US Federal Reserve (Fed) in this June with a common denominator: their economies will grow this year and the next more than expected and inflation will also be higher. Economists and investors are now sharpening their ingenuity to read beyond the words of Christine Lagarde and Jerome Powell, presidents of the world’s most important central banks, who chain an exceptional situation caused by the Covid-19 pandemic with zero interest rates percent and massive debt purchase programs.

Beyond the interpretations, Lagarde’s message reviewing growth and inflation upwards, and especially Powell’s statements about two possible increases in the price of money for 2023, have put investors on guard. The Federal Reserve could begin to react to the rise in prices earlier than expected and its decisions will cause a shock wave on a planetary scale. The market is now eager to know when the monthly debt purchase programs, of 120,000 million dollars (100,460 million euros) in the Fed, will begin to relax, as a step before the rate hike.

For now, the biggest problem due to price tensions is clearly on the other side of the Atlantic, to the point of raising concerns about an excessive warming of the US economy, which this year will grow at 7% according to the Fed estimates. In the eurozone, Lagarde’s forecasts suggest that inflation could end the year at 1.9% (compared to 1.5% estimated in March), while the Fed expects the core (excluding energy and food) to end at the 3%, well above the 2.2% forecast in March. And that after the shock of the 5% rise in prices with which the US general index closed in May.

Carmen Reinhart, vice president and chief economist of the World Bank, pointed out this week “there is cause for concern that the inflationary component is more than transitory, and could generate higher interest rates and dynamics that are difficult to control.”

Analysts from the firm A&G Private Banking point out that in the rise in inflation in the US there are transitory elements such as increases in components due to bottlenecks in supply and the friction of a macro reopening, but “some effect components are beginning to be seen. more permanent, with notable rallies well above expectations, in addition to the so-called greenflation , which is the rise in prices of goods and services due to the transition to a sustainable economy ”, they explain.

Inflation in the US

“We are increasingly concerned about inflation in the US,” they point out from Bank of America. His concern has to do with the fact that prices are at the highest level since 2008, while core inflation is at its highest since 1992, an increase to which fiscal stimuli, with direct aid to citizens, have decisively contributed. And they add: “in principle we see that the price increase is transitory and due to base effects, but we are increasingly restless since we believe that the United States economy may be overheating,” they explain. And all this with a possible effect on the markets.

“The risk of this scenario could push the Fed towards normalization of policies and, in some scenarios, trigger volatility,” they conclude. A view with which Martin Wolburg, Senior Economist at Generali Insurance AM agrees: “We see the risk of an increase in international yields driven by the United States.”

However, from the Swiss bank Julius Baer they are more cautious regarding the movements of the Fed according to the evolution of inflation. Its chief economist, David Kohl, points out that the 5% price hike in the US in May is largely due to factors that open up the economy. If these factors are eliminated (second-hand car sales, household furniture, etc…), the inflation figure drops to 3%. “Most price increases are transitory over a six to nine month horizon. For this reason, we hope that the Federal Reserve recognizes this point and refrains from signaling a tightening of monetary policy ”, he explains.

The eurozone does not worry analysts regarding the evolution of its prices, although Bank of America experts do notice a great confusion in the words of Christine Lagarde. “GDP forecasts were revised upwards significantly for this year from (4% to 4.6%) and next. That’s a big change in growth without a clear trigger, and a big change in the link between growth and inflation. The interpretation would be that the central bank cannot (or does not want or cannot accept) to do something about the inflation stagnant below the target whatever the growth forecast, otherwise they would have had to act ”, they explain. Not surprisingly, the current price outlook in the euro zone is very far from that of the United States.

The markets reacted quickly to Jerome Powell’s words after the Fed meeting. Stock markets fell moderately, interest rates on debt rose and the dollar also came out stronger. From Bank of America they explain that if high inflation continues, the Fed will react by supporting the dollar at the end of this year. A view on which Julius Baer’s chief economist does not agree: “the strength of the dollar in response to expectations of an earlier tightening of US monetary policy will not be long-lasting and we maintain our opinion on a change of one euro per $ 1.21 over three months, “he explains.

‘Tapering’

The withdrawal of stimuli (tapering, in English) by central banks is the great unknown that worries investors. Anna Stupnytska, global economist at the manager Fidelity International, warns of an important appointment in August that may shed some clues. This is the Jackson Hole symposium, which brings together the world’s leading central bankers. “We believe that the Fed will be cautious and restrained in reducing monetary stimulus,” he explains. In Goldman Sachs they expect that in the summer the purchases of debt in Europe will be reduced from 80,000 million a month to 75,000 million for a simple matter of seasonality.

As Bankinter analysts point out, at Wednesday’s meeting, Powell acknowledged that deliberations on reducing asset purchases had begun. “The Fed will begin to assess progress towards its employment and inflation targets meeting by meeting, and it will be announcing in advance to the market,” they say.

However, at Deutsche Bank they believe that tapering will not wait long: “Our economists think that we will have signs of tapering after the summer and some official announcement at the end of the year. The movements could accelerate if inflationary pressure grows ”.

“Now it will be up to Powell and other Fed speakers to reassure markets that the tightening in 2023 need not be disruptive,” says Seema Shah, Chief Strategist at Principal Global Investors. Until then, a tough task awaits the Fed, and to a much lesser extent the ECB, in which to ensure that the withdrawal of the entire network of monetary stimuli launched with the crisis does not create the financial instability that it precisely wanted to avoid with its implementation. on going.

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