Powell’s ‘Transitory’ Retreat Is Just the Beginning

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By dropping the term “transitory,” Federal Reserve Chair Jerome Powell did more than just rectify a grievous mischaracterization of inflation that he had been stuck with for far too long. He also highlighted inflation as a big danger to the economy and financial markets, not because more price rises are necessarily harmful (they aren’t), but because the Fed’s communication process and policy actions have lagged behind reality. The catch-up process—which, given the delays thus far, must be quick—could destabilize markets and the economy. This did not have to be the case.

For months, Powell claimed that inflation was just temporary. Rather of revisiting his assumption in light of overwhelming evidence to the contrary on a timely basis, he embraced an ever-more elastic interpretation of the term that favored longer and arbitrary time periods at the expense of economic analytical rigor.

This insured that the Fed kept making enormous monthly purchases of market securities at a time when the economy was performing well, the housing market was booming, and the liquidity-fueled “everything rally” in financial assets was displaying signals of excessive risk-taking.

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This Fed-driven liquidity paradigm was well received by investors. After all, nothing is more comforting for asset acquisitions than a very big buyer with a massive balance sheet that is engaged on a regular basis and makes non-commercial purchases. Indeed, the assumption that the Fed has been completely price agnostic in its monthly purchases of over $100 billion dollars has effectively made others less price agnostic, further divorcing asset prices from economic and business fundamentals.

Read More: Deadline Approaching For The $1,400 Plus Up Fourth Stimulus Check

Powell’s frequent assurances that inflation was temporary led many investors to believe—or, at the very least, act as though this peculiar market configuration might persist indefinitely. Despite what is meant to be a negative association, the consequence was not only record risk assets such as equities and cryptocurrencies, but also high prices for risk-free government bonds (low yields).

Markets were taken aback Tuesday by the chair’s abrupt rejection of transitory inflation only a few days after his re-nomination by President Joe Biden. Stocks sank, short-term US government bond rates increased, and commodities declined. It didn’t help matters that Powell made his inflation U-turn just as markets were attempting to analyze the impact of omicron, a new Covid strain expected to be more contagious and perhaps vaccine-evasive, on economic activity.

The difficulty today is that such a late awakening to the realities of inflation raises the dangers of mismanaging the Fed’s policy catch-up process, exposing the economy to an unwarranted, Fed-induced downturn. As I have argued in previous columns, such a policy blunder would exacerbate the miseries of an economy in which the most vulnerable portions of the population are already dealing with inflation taking a significant bite out of their income and too many Americans have been priced out of the home market.

This is all really bad and absolutely avoidable.

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