Full Federal Reserve policy statement Sept 22, 2021

(Reuters) – Following is the full statement issued by the Federal Open Market Committee on Sept. 22, 2021:

The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.

With progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen. The sectors most adversely affected by the pandemic have improved in recent months, but the rise in COVID-19 cases has slowed their recovery. Inflation is elevated, largely reflecting transitory factors. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.

The path of the economy continues to depend on the course of the virus. Progress in vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. Last December, the Committee indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals. Since then, the economy has made progress toward these goals. If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas I. Barkin; Raphael W. Bostic; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Mary C. Daly; Charles L. Evans; Randal K. Quarles; and Christopher J. Waller.

Dollar falls as U.S. consumer price rises temper in July, data show

By John McCrank

NEW YORK (Reuters) -The dollar fell on Wednesday after U.S. inflation data showed consumer price increases eased in July, taking some pressure off the Federal Reserve to begin scaling back the monthly bond purchases that are part of its toolbox to support the economic recovery.

The dollar index, which measures the greenback against a basket of other major currencies, was down 0.17% at 92.915 at 3:05 p.m. ET (1905 GMT).

Earlier, the U.S. currency hit 93.195, its highest since April 1, and not far off of its 2021 high of 93.439, but it sold off after data showed the consumer price index rose 0.5% last month after climbing 0.9% in June. Excluding the volatile food and energy components, the CPI rose 0.3% after increasing 0.9% in June.

Economists polled by Reuters had forecast overall CPI would rise 0.5% and core CPI 0.4%.

While prices are still rising, the Fed has said it expects inflationary pressures to moderate over time as supply catches up with demand following months of COVID-19 lockdowns.

“The CPI report was enough to cause a bit of profit taking for the U.S. dollar, but at the end of the day, it’s not a game changer for the Fed,” said Kathy Lien, managing director at BK Asset Management. “They’re still going to be announcing taper,” likely within the next six weeks.

The greenback had enjoyed a lift from last week’s better-than-expected U.S. jobs data, as well as from remarks by Fed officials about tapering bond purchases and, eventually, raising rates, sooner than policymakers elsewhere.

Looking forward, the Fed will depend on data when it comes to the timing of the dialing back of its asset purchases, said Edward Moya, senior market analyst at OANDA.

“It’s all going to be all about next month’s employment report and if that does not impress, tapering, as far September goes, might even get pushed out towards the end of the year,” he said.

In Europe, investor sentiment has declined, with a survey showing a third straight month of deterioration in Germany as rising global COVID-19 cases keep markets on edge.

“Investors have to take on board the possibility of news on Fed tapering at a time when COVID is still very apparent in various parts of the world,” said Rabobank analyst Jane Foley.

“The consequence of this is likely to be a firmer dollar,” she added, especially if the euro breaches its 2021 low.

The euro gained 0.16% against the greenback, to 1.17395, following six straight sessions of losses and having fallen as low as 1.1706 in early deals in Europe, near the year’s low of $1.1704.

Sterling gained 0.2% to 1.38645 against the dollar, pulling back from a two-week low.

The yen was up 0.12% at 110.445, after dropping for five consecutive sessions against the dollar.

South Korea reported a record number of COVID-19 cases on Wednesday, while outbreaks in China, Southeast Asia and Australia grow steadily.

The Australian dollar and the New Zealand dollar , seen as riskier currencies, rose after the U.S. CPI report, last up 0.33% and 0.5% respectively.

In cryptocurrencies, bitcoin touched $46,787.60, its highest since May 17. Bitcoin was last up 1.5% at $46,304.54, while ether, the second-biggest cryptocurrency, was up 2.7% at $3,226.18.

(Reporting by John McCrank in New York; additional reporting by Ritvik Carvalho in London; Editing by Kirsten Donovan and Marguerita Choy)

Blip or bad moon rising? Fed meets amid COVID-19 surge, inflation jitters

By Howard Schneider

WASHINGTON (Reuters) – The Federal Reserve will conclude its latest policy meeting on Wednesday weighing the risks of a COVID-19 resurgence in the United States and a potentially slower economic recovery against a developing inflation threat that had been its main focus.

Fed officials are expected to continue their debate over when to wean the economy from the measures put in place more than a year ago to fight the pandemic’s economic aftershock, and in particular to discuss when to reduce the $120 billion in Treasury bonds and mortgage-backed securities the U.S. central bank is buying each month to hold down long-term interest rates.

But that discussion, begun in earnest just six weeks ago when U.S. cases of COVID-19 were falling under the influence of vaccinations, has been complicated by the rapid spread of the more infectious Delta variant of the virus, the renewal of crisis conditions in some hospitals, and reinstated mask mandates in some cities.

Though focused mostly on the 40% of the adult U.S. population that remains unvaccinated, the current outbreak nevertheless raises fresh tensions for the Fed over whether planning to fend off inflation should be the top concern at a time when the health crisis may yet curb an otherwise ebullient recovery.

“Sadly, (Fed Chair Jerome) Powell will have to acknowledge the downside risks that are beginning to emerge,” Diane Swonk, chief economist at Grant Thornton, wrote ahead of the Fed’s two-day policy meeting this week. “The question mark is how spread of the Delta variant affects the return to work and whether it dampens some of the demand for services” that had begun to lead the recovery and pull millions of sidelined people back into jobs.

The economy still is 6.8 million jobs short of where it was before the pandemic’s onset in early 2020, and Powell has said the country remains “a ways off” from the progress he wants to see before changing any of the Fed’s efforts at encouraging job growth. Powell will hold a news conference following the 2 p.m. EDT (1800 GMT) release of the Fed’s latest policy statement.

INFECTIONS AND INFLATION

The Fed remains in full crisis-fighting mode more than 16 months into a national state of emergency, continuing to hold its benchmark overnight interest rate near zero and buying bonds at a pace some policymakers have begun to question openly as too aggressive. Inflation is taking off, they note, and housing prices have hit record highs thanks in part to the relatively low interest rates on home mortgages.

To avoid bigger problems down the road the Fed should pull back “sooner rather than later,” Dallas Fed President Robert Kaplan said after the June 15-16 policy meeting. St. Louis Fed President James Bullard has voiced similar sentiments – only to see Missouri’s second-biggest city reimpose an indoor mask mandate amid a rapid coronavirus outbreak in the state.

Nationally, daily infections have risen about fourfold since the Fed met in June, making what had seemed a straightforward process – a turn from fighting recession to managing the rising prices and other risks of a strong recovery – into a more nuanced debate over how to continue planning for the pandemic’s end while also acknowledging its persistence.

A new Reuters poll showed 160 of 202 economists, or about 80%, said the spread of new coronavirus variants was the biggest risk to the recovery.

The latest surge in cases has not shown up clearly yet in the economic data. Consumer confidence remains high and people are still boarding planes and heading to restaurants.

Still, Bank of America analysts recently drew a cautionary tale from Michigan, where a wave of infections in February appeared to dent hiring and consumer spending.

“So far we have seen little evidence of the Delta variant significantly affecting economic activity or spending on services,” those analysts wrote. But “we have good reason to be concerned about the current outbreak and what it means.”

TAPER TALK CONTINUES

Amid those risks, there’s also no guarantee that inflation will fade on a timetable within the Fed’s comfort zone – possibly leaving the central caught between slower growth and rising prices, the worst of both worlds.

A new Fed framework ostensibly allows inflation to run above the central bank’s formal 2% target to give the economy more room to generate jobs.

That approach, however, was designed after a decade of low inflation, and on an expectation the chief challenge would be raising the weak pace of price increases. Yet as of May, with the world economy beset by supply-chain problems and other challenges tied to the economic reopening, the Fed’s preferred inflation measure was nearly twice the target rate.

If that trend continues “they would have to say at some point ‘we do have to remove accommodation’ … and they could not wait for maximum employment” before raising interest rates, as their current policy pledges to do, said Bill English, a Yale School of Management professor and former head of the Fed’s monetary affairs division.

For that reason alone, Fed planning over how to reduce its bond-buying program is expected to continue. The central bank wants the monthly purchases to end before considering an interest rate increase, and the process of tapering them could take perhaps a year to complete – a lengthy runway if inflation persists and rate increases become more urgent.

Officials have also promised ample advance notice before actually making any change, adding more months to the timetable.

So far, officials are not foreclosing any option. Market analysts say they expect the Fed to clarify its plans for ending the bond-buying in the fall, and perhaps begin reducing purchases early next year.

That presumes U.S. hiring continues, and that travel, dining out, and other close-contact social activities also recover.

In an update to its World Economic Outlook, the International Monetary Fund on Tuesday raised its forecast for U.S. growth in 2021 to a torrid 7%. But in a related blog, Gita Gopinath, the IMF’s chief economist, cautioned central banks not to be distracted into “prematurely tightening policies” by a rise in inflation that was expected to fade on its own.

“The recovery is not assured until the pandemic is beaten back globally,” she wrote.

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)

Fed says shortages of materials, hiring problems holding back recovery

WASHINGTON (Reuters) -Shortages of materials and “difficulties in hiring” are holding back the U.S. economic recovery from the coronavirus pandemic and have driven a “transitory” bout of inflation, the Federal Reserve said on Friday.

“Progress on vaccinations has led to a reopening of the economy and strong economic growth,” the U.S. central bank said in its semiannual report to Congress on the state of the economy. However, “shortages of material inputs and difficulties in hiring have held down activity in a number of industries.”

The report will be the subject of hearings in Congress next week, including testimony from Fed Chair Jerome Powell about the outlook for the economy, inflation, and the transition of monetary policy as the impact of the pandemic recedes.

The report released by the Fed on Friday is largely backward-looking, but it documents the central bank’s view that the recovery remains on track as firms and families navigate a complicated economic reopening.

Prices have risen faster than expected, for example, and while the supply bottlenecks and other factors driving the price hikes are expected to ease over time, “upside risks to the inflation outlook in the near term have increased,” the Fed said.

Hiring has also slowed for an unexpected reason: Companies want to bring on more employees, but not enough workers are ready to take those jobs as they cope with ongoing health and family concerns and can rely on continued federal unemployment benefits to help pay the bills.

“Many of these factors should have a diminishing effect on participation in the coming months,” the Fed said, though the speed and strength of that labor market recovery also remains uncertain.

The central bank, however, said available data suggest “a further robust increase in demand” occurred from April through June.

“Against a backdrop of elevated household savings, accommodative financial conditions, ongoing fiscal support, and the reopening of the economy, the strength in household spending has persisted,” while the financial system remains “resilient,” the Fed said.

(Reporting by Howard SchneiderEditing by Paul Simao)

Analysis – A fine mess: Weak inflation prompts a global central bank reset

By Howard Schneider and Leika Kihara

WASHINGTON (Reuters) – It is an article of faith among central bankers that the decisions they make about how much money to create and what interest rate to charge for it will determine the rate of inflation – at least over moderate lengths of time.

For more than a decade that belief has been undermined by inflation that has remained weak despite trillions of dollars pumped into the world’s biggest economies through quantitative easing programs and ultra-low interest rates.

That prompted the top central banks to review how they do business, and on Thursday the European Central Bank joined the Federal Reserve and the Bank of Japan in pursuing an ambitious reset in hopes of reasserting control.

The ECB’s new framework, in contemplating the occasional “transitory period” when inflation exceeds its formal 2% target in hopes of ensuring that target is met over time, is a step short of the more explicit promise the U.S. central bank made last year to encourage periods of high inflation to offset years when price increases were too weak.

But their shared diagnosis paints a similarly troubling picture of a developed world seemingly set in a rut of slow economic growth, low productivity, aging populations, and perennially weak inflation that may be difficult to coax higher.

“The euro area economy and the global economy have been undergoing profound structural changes,” the ECB said in announcing its new framework, echoing language used by Fed officials in announcing their new strategy last year. “Declining trend growth, which can be linked to slower productivity growth and demographic factors, and the legacy of the global financial crisis have driven down equilibrium real interest rates.”

That, in turn, has given the ECB less room to use interest rate policy alone to help boost economic activity, and forced it, like the Fed, to resort more often to other measures – bond-buying for example – when economic conditions weaken.

The BOJ led the way down that path early this century.

The aims of the new U.S. and European inflation strategies, and those pursued so far unsuccessfully in Japan, are the same: Get the pace of price increases high enough so inflation-adjusted interest rates can also increase, giving the central banks room to use rate cuts as their main policy tool in times of stress.

CHASING AN AVERAGE

The concept of using inflation averaging has been slow to evolve. All three central banks at first adopted simple inflation targets of 2%, trusting that they understood inflation dynamics well enough to hit that level and stay there.

They didn’t.

Over time, they realized that between technology, globalization, demographics and other factors, inflation had become difficult to budge. Even more problematic, the continued “misses” against a well-publicized target risked resetting public expectations that inflation would remain weak.

Research by current and former Fed officials raised the stakes. They found that in a situation where equilibrium interest rates were low and central banks were repeatedly forced to cut their policy rates to near zero, inflation expectations would fall – permanently, a damaging outcome that would cement weak prices, wages, and growth as the norm.

Fed Vice Chair Richard Clarida, whose earlier academic research affirmed the advantages of simple inflation targeting, detailed this past January how subsequent studies by New York Fed President John Williams and others concluded more aggressive approaches were needed when interest rates were expected to keep collapsing to zero.

Interest rates stuck near zero “tend to deliver inflation expectations that, in each business cycle, become anchored at a level below the target,” Clarida said in a presentation to Stanford University’s Hoover Institution. “It can open up the risk of the downward spiral in both actual and expected inflation that has been observed in some other major economies.”

‘HISTORIC SHIFT’

The Fed’s new policy has been in place for just over 10 months. Its experience shows the challenges the ECB now faces.

The coronavirus pandemic and subsequent economic reopening have complicated the inflation outlook, with supply bottlenecks driving up prices more than – and perhaps for longer than – anticipated and a labor squeeze starting to drive up workers’ pay.

That has led to some new hawkish voices inside the Fed and hints at faster interest rate hikes from the U.S. central bank despite its stated promise to let inflation run above target “for some time.”

With the Fed yet to prove its new design in practice, bond markets have noticed.

The yield on the 10-year U.S. Treasury note, far from anticipating higher inflation and growth, has been falling, and on Thursday hit 1.25%, the lowest level since mid-February and a drop of nearly half a percentage point from mid-May.

As with the Fed, the ECB will have to translate its new strategy into policies that work.

The new strategy marks “a historic shift for the ECB,” by acknowledging inflation may need to exceed 2% at some point, wrote Andrew Kenningham, chief Europe economist for Capital Economics. But it “will not make it easy for the ECB to escape from the grips of low inflation.”

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)

Fed officials say important they be ‘well positioned’ to act, minutes show

By Howard Schneider, Jonnelle Marte and Lindsay Dunsmuir

WASHINGTON (Reuters) – Federal Reserve officials last month felt that substantial further progress on the economic recovery “was generally seen as not having yet been met,” but agreed they needed to be poised to act if inflation or other risks materialized, according to the minutes of the U.S. central bank’s June policy meeting.

In minutes that reflected a divided Fed wrestling with the onset of inflation and financial stability concerns, “various participants” at the June 15-16 meeting felt conditions for reducing the central bank’s asset purchases would be “met somewhat earlier than they had anticipated.”

Others saw a less clear signal from incoming data and cautioned that reopening the economy after a pandemic left an unusual level of uncertainty and required a “patient” approach to any policy change, stated the minutes, which were released on Wednesday.

Still “a substantial majority” of officials saw inflation risks “tilted to the upside,” and the Fed as a whole felt it needed to be prepared to act if those risks materialize.

“Participants generally judged that, as a matter of prudent planning, it was important to be well positioned to reduce the pace of asset purchases, if appropriate, in response to unexpected economic developments, including faster-than anticipated progress toward the Committee’s goals or the emergence of risks that could impede the attainment of the Committee’s goals,” the minutes stated.

The Federal Open Market Committee at its meeting last month shifted towards a post-pandemic view of the world, dropping a longstanding reference to the coronavirus as a constraint on the economy and, in the words of Fed Chair Jerome Powell, “talking about talking about” when to shift monetary policy as well.

The start of that discussion, along with interest-rate projections showing higher borrowing costs as soon as 2023, caused investors to anticipate the Fed will move faster than expected to end its support for an economy still afflicted by high levels of unemployment and, now, rising inflation.

Long-term Treasury yields are near five-month lows, and the gap between those and shorter-term yields has been narrowing, a development often associated with skepticism about the outlook for longer-term economic growth.

In this case, Cornerstone Macro analyst Roberto Perli wrote recently, “the market views the perceived Fed shift as harmful to the long-term prospects for the U.S. economy,” with the Fed’s stated commitment to getting back to full employment seen as weakening in the face of higher-than-anticipated inflation.

Powell, speaking to reporters after the end of last month’s policy meeting, said any increase in the Fed’s benchmark overnight interest rate from the current near-zero level remained far off. He said, however, that the Fed would begin a “meeting-by-meeting” assessment of when to start reducing its $120 billion in monthly purchases of Treasury bonds and mortgage-backed securities, and of how to announce its plans for doing so.

The U.S. economy, he said at that point, was still “a ways away” from the progress on job creation the Fed wants to see before reducing its asset-purchase program, which supports the recovery by making the purchase of homes, cars and similar items more affordable by holding down borrowing costs for households and companies.

But “we’re making progress,” Powell said in the briefing, and to such an extent that he and his colleagues now needed to “clarify … thinking around the process of deciding whether and how to adjust the pace and composition of asset purchases.”

TAPERING TIMELINE

What investors are wondering is how fast the discussion will spool out and when the actual “taper” may begin.

Several regional Fed policymakers have since said they felt the economy was near the point where the central bank should pull back. However, even some of them have indicated it will take several meetings to develop and announce a plan for reducing the bond purchases.

The Fed’s policy-setting committee meets eight times a year, with the next two meetings scheduled for July 27-28 and Sept. 21-22. In the interim, the central bank will hold its annual research conference in Jackson Hole, Wyoming, a setting that Fed chiefs have often used to signal policy changes.

The U.S. economy added 850,000 jobs in June. If that pace of hiring continues over the summer, it “could prompt the Committee to accelerate the tapering timeline” from an expected start in January to as soon as October, analysts from Nomura wrote last week.

Economists polled by Reuters expect the Fed to announce a strategy for tapering its asset purchases in August or September, with the first cut to its bond-buying program beginning early next year.

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)

U.S. jobless claims dropping faster in states ending federal benefit

By Howard Schneider

WASHINGTON (Reuters) – Ongoing claims for U.S. unemployment insurance have dipped faster in recent weeks in states ending federal benefits this summer than in states keeping the $300 weekly supplement in place until the fall, according to government data through last week.

From the week ending May 1 through the week ending June 12, continuing claims for state unemployment benefits fell 17.8% in the 26 states ending benefits early, to 990,000, and by 12.6%, to 2.18 million, in the rest of the country, according to a Reuters analysis of weekly federal unemployment data.

The data do not yet answer the larger and arguably more important question of whether hiring will also accelerate in those states, the outcome an almost all-Republican group of governors says is the goal of cutting the benefits early.

Weekly data from small business time provider Homebase through the week ending June 20 in fact has shown no pickup in hiring in the states cancelling unemployment benefits. To the contrary the other states appear to have added jobs faster in recent weeks – a possible consequence of the fact that large Democratic-led states like California and New York have recently lifted most of the remaining restrictions put in place to fight the pandemic.

The states stopping benefits as a group have also pulled closer to their pre-pandemic levels of unemployment, suggesting less room for improvement.

The issue of how unemployment benefits are impacting the recovery of the U.S. job market has become a core concern among Federal Reserve and other policymakers as they try to determine how fast national employment might rebound to pre-pandemic levels, a judgment hard to make until the economy is fully reopened and benefit levels returned to normal.

Twelve states have already halted benefits in what has been a largely partisan split between Republican governors arguing that the pandemic emergency unemployment payments are now discouraging people from working, and Democratic governors who feel people still need support as the pandemic wanes.

The states stopping benefits early include the entire Deep South, where pandemic unemployment has fallen hard on the large Black population, but only one state, Louisiana, with a Democratic governor. Only two Republican-led states, Vermont and Massachusetts in the Northeast, plan to continue the payments until they end nationwide in September.

The data overall suggest “more downward momentum in initial and continuing claims over the next few weeks,” said Jefferies economist Thomas Simons. Sky-high unemployment claims have been a hallmark of the pandemic, topping 23 million at one point in the spring of 2020 as the coronavirus took hold, more than 10 times the level at the start of the year.

(Reporting by Howard Schneider; Editing by Andrea Ricci)

Transitory or here-to-stay? Investors try to read the inflation clues

By David Randall

NEW YORK (Reuters) – From lumber prices to wages and inventories: Reading the clues around inflation has turned into an investor obsession.

The combination of supply bottlenecks from the reopening of the global economy and the resumption of economic growth sent consumer prices in May up by the largest annual jump in nearly 13 years. Employers are raising wages as they compete for scarce workers while retailers have limited inventories because of shipping and production delays.

As investors assess the risks of rising prices to financial markets, however, some think the biggest gains in inflation are already in the rear-view mirror. That is in line with the Federal Reserve’s notion that inflation will be “transitory.”

The Fed meets on Tuesday and Wednesday, and investors will parse every word of its post-meeting statement.

The Fed has been buying $80 billion in Treasuries and $40 billion in mortgage-backed securities monthly, putting downward pressure on longer-term borrowing costs to encourage investment and hiring. Discussions about tapering those purchases are likely at this week’s policy meeting.

“As long as the increase in inflation is modest, stocks could continue to move higher,” said Russ Koesterich, portfolio manager of the $27.6 billion BlackRock Global Allocation Fund.

Koesterich thinks inflation will likely run above trend lines well into 2022 given the bottlenecks in global supply chains. Yet disinflationary forces such as an aging global population and gains in efficiency due to technology will keep a lid on “any 1970’s-style inflation scare,” he said.

Investors who bet on inflation typically move into groups better-positioned to weather price rises, like materials and energy and companies with pricing power. Value stocks, in contrast, benefit from a broad economic recovery that does not become weighed down by steeply rising prices.

Koesterich said his fund has been decreasing its positions in growth stocks like technology and adding to industrials and European banks.

Jeff Mayberry, portfolio manager of the DoubleLine Strategic Commodity fund, thinks May’s inflation numbers will be the highest for the remainder of the year and remains bullish on oil, which hit a multi-year high on Friday. He sees the commodity benefiting from economic growth.

“The market was looking for a reason for inflation to be transitory and they got it,” Mayberry said of May’s inflation number, noting that some of the larger contributors came from short-term factors such as a spike in the price of rental cars.

Ernesto Ramos, chief investment officer at BMO Global Asset Management, also sees price rises as transitory. He cites a drop in lumber prices from May’s high that suggests supply chain bottlenecks will subside and “give us another reason to believe that inflation will remain under control.” Lumber prices are down more than 40% from record highs hit in early May.

REASONS TO WORRY

While the majority of investors believe inflation is transitory, according to a Bank of America fund manager survey, worries remain.

“Inflation has been the most discussed topic with clients for weeks, bordering on obsession,” wrote analysts at Morgan Stanley led by Michael Wilson. Those analysts think the rate of change on inflation is peaking.

Greg Wilensky, head of U.S. Fixed Income at Janus Henderson, said he has been buying more Treasury-Inflation Protected Securities as the break-even rate – a measure of expected inflation in the bond market – has retreated to near its February levels.

While he is not “changing my base case” that high inflation will prove to be transitory, “the risks around the base case continue to skew toward the upside on inflation,” given the persistent difficulties companies are having hiring lower-paid workers, Wilensky said.

The Fed’s statement could give important clues.

“I’m going to watch the Fed on Wednesday and if they treat these numbers with nonchalance it is a green light to bet heavily on the inflation trade,” Paul Tudor Jones of Tudor Investment Corp told CNBC on Monday. He said he would be “really concerned arguing that inflation is transitory” with inventories at a “record low” while demand is “screaming.”

Morgan Stanley Chief Executive James Gorman told CNBC on Monday that “my gut tells me that this economy is recovering faster, inflation is moving quicker and inflation may not be as transitory as we all expect.” He cited the global economic recovery and record levels of fiscal and monetary support.

“Even if investors disagree with the Fed’s often-stated mantra that inflation is just transitory, they have learned to respect the massive influence the world’s most powerful central bank has when possessing such conviction that is not even ‘thinking about thinking’ about easing its foot off the stimulus accelerator,” said Mohamed El-Erian, chief economic adviser at Allianz. “The resulting comfort with continued ultra-loose financial conditions is supportive in the short run of elevated stock prices and low yields.”

(Reporting by David Randall; Editing by Megan Davies and Dan Grebler)

U.S. inflation will accelerate if recovery stays on track: Kemp

By John Kemp

LONDON (Reuters) – U.S. consumer prices are rising at the fastest rate for several years, as the economy recovers from the coronavirus recession and manufacturing supply chains struggle to keep up with demand.

But the rate of inflation is still being flattered by the relatively modest increase in energy prices, masking the impact of faster increases in food products and other commodities.

If energy prices rise further in the second half of 2021 and into 2022, as the expansion matures, inflation could prove more persistent than anticipated by officials at the Federal Reserve.

The U.S. consumer price index has increased at a compound annual rate of 2.55% over the last two years, the fastest for more than eight years, according to data from the U.S. Bureau of Labor Statistics.

But energy prices have risen at an average rate of only 2.20% over the same period, which uses 2019 rather than 2020 as a baseline to avoid distorted comparisons caused by the first wave of the epidemic last year.

Prices for non-energy items have increased at a rate of 2.59%, the fastest for more than 12 years since the financial crisis of 2008/09.

Inflation has accelerated most sharply in the goods sector, where manufacturers have struggled to meet the surge in demand, especially for motor vehicles and consumer electronics.

As a result, prices for merchandise other than food and energy are increasing at the fastest rate since the early 1990s.

INFLATION OUTLOOK

U.S. central bank officials have said they believe the acceleration will prove temporary, with price increases slowing in 2022 and 2023.

But inflationary pressures normally intensify as a business cycle becomes longer and more capacity constraints emerge.

It would be unusual for inflation to slow as employment rises, manufacturing capacity becomes more fully utilized and service sector output increases.

The relationship between inflation and the business cycle is often obscured because the cycle is presented as if it exists in only two states: recession and expansion.

The two-state model is a simplification. In fact, the rate of growth is highly variable; recessions are only the most pronounced slowdowns.

The long boom between 1991 and 2001 was almost derailed by a sharp mid-cycle slowdown in 1998/99 caused by the East Asia financial crisis, Russian debt default and failure of the Long-Term Capital Management hedge fund.

The expansion between 2001 and 2007 lost momentum in its early stages and threatened to stall in 2002/2003, prompting the Federal Reserve to cut interest rates again to try to entrench the recovery.

During the expansion of 2009 to 2020, a similar early-recovery stall occurred between 2010 and 2012, prompting the Fed to launch further rounds of bond buying.

Later in the same expansion, there was an even more serious mid-cycle slowdown (in effect an undeclared recession) in 2015/16, which contributed to the populist revolt and election of Donald Trump as U.S. president.

Experience suggests inflationary pressures are only likely to abate if the recovery threatens to stall or enters a mid-cycle slowdown.

If the U.S. economy avoids both in 2022/23, inflation will accelerate further and necessitate a tightening of monetary policy earlier than the central bank has indicated.

(Editing by Catherine Evans)

Exclusive: Fed Chair Powell says won’t allow ‘substantial’ overshoot of inflation target – April 8 letter to U.S. senator

By Ann Saphir

(Reuters) – The U.S. economy is going to temporarily see “a little higher” inflation this year as the economy strengthens and supply constraints push up prices in some sectors, but the Federal Reserve is committed to keeping any overshoot within limits, Fed Chair Jerome Powell said in an April 8 letter.

“We do not seek inflation that substantially exceeds 2 percent, nor do we seek inflation above 2 percent for a prolonged period,” Powell told Senator Rick Scott in a five-page letter responding to a March 24 letter from the Florida Republican raising concerns about rising inflation and the Fed’s bond buying program. “I would emphasize, though, that we are fully committed to both legs of our dual mandate – maximum employment and stable prices.”

Scott, while not on the Senate Banking Committee that directly oversees the Fed, nonetheless has been a vocal critic of Powell. He has warned that the Fed’s low interest rates and bond-buying program will force prices higher, hurting families and businesses.

His office provided Powell’s letter to Reuters, and suggested the response did not allay the senator’s concerns.

“The data is clear that inflation is rising, and Chair Powell continues to ignore this growing problem,” Scott’s office told Reuters in the email. “Senator Scott remains concerned about the impact inflation will have on low and fixed-income American families, like his growing up. He is calling on Chair Powell to wake up to this threat, lay out a clear plan to address rising inflation and protect American families.”

Powell in his letter said that low inflation constrains the Fed’s ability to offset economic shocks with easy policy, and that after a decade of too-low inflation, the Fed is now aiming for inflation moderately above 2%.

“We understand well the lessons of the high inflation experience in the 1960s and 1970s, and the burdens that experience created for all Americans,” Powell said in the letter. “We do not anticipate inflation pressures of that type, but we have the tools to address such pressures if they do arise.”

(Reporting by Ann Saphir; Editing by Chizu Nomiyama and Dan Burns)