Global Daily – Fed to raise inflation projection, but no new taper hints

The meeting is coming at another extraordinary time for the US economy – with the pandemic on the back foot, the country has largely reopened, and the economy has recovered much more quickly than anticipated. The most striking feature of the recovery has been the degree to which the rebound in demand has outpaced the rebound in supply, and the consequences for inflation that this is having. We concur with most FOMC members that the current inflation we are witnessing reflects the historically exceptional circumstances we currently find ourselves in, and that it is unlikely to last. However, the magnitude of price rises in both April and May has been unsettling, and the risk is that this pushes inflation expectations higher, ultimately feeding through to a more sustained rise in inflation over the medium term.

Big upward revision to inflation projection, but overshoot will still be described as transitory – We are not there yet, however. The most likely course is that inflation decelerates over the coming months, settling back at more normal levels later this year. It is even possible we could get one or two weak readings in the months ahead, as some price rises look unsustainable and vulnerable to payback (particularly in used cars, a category driving 1/3 of the overshoot in April/May). In the meantime, while the Michigan survey of consumer inflation expectations remains elevated after a sharp rise since the beginning of the year, it looks to have stabilised at levels that have historically been consistent with 2% inflation. As such, although we expect a significant upward revision to the Fed’s current 2.4% forecast for PCE inflation in 2021 – perhaps a rise of more than a percentage point – we expect the FOMC statement to continue to describe the current inflation overshoot as transitory, and Chair Powell is likely to mount a vigorous defence of this thinking in the press conference.

Rates lift-off could be brought forward to 2023, but further tapering hints are unlikely – Alongside the rise in the inflation projection, we expect a more modest rise in the GDP growth forecast for 2021 (which stood at 6.5% in March on a Q4/Q4 basis), and perhaps a rise in the ‘dots’ projections for the fed funds rate. As of March, the median FOMC member foresaw no rate hikes until 2024. It is possible that a few more members have joined the 7 members who in March expected some form of tightening by 2023, and this could potentially push the median to expect rate hikes to start in 2023. This would still be less aggressive than market expectations, however. At the same time, while Chair Powell might acknowledge that the Committee is now ‘talking about talking about’ a tapering of its asset purchases, we do not expect any concrete hints on this at the press conference. We continue to think a formal taper announcement could come by the September meeting – perhaps telegraphed at the Jackson Hole Symposium. This would pave the way for tapering to start in Q4. (Bill Diviney)