(Bloomberg) — Federal Reserve Chair Jerome Powell signaled on Wednesday that inflation is now enemy No. 1 to keeping the economic expansion on track and returning the labor market to something approaching ebullient pre-pandemic levels.
In an abrupt policy pivot, the Fed sped up the drawdown of its asset-purchase program and laid out a road map for a series of interest-rate increases over coming years, started with three hikes in 2022. Powell also raised the possibility that the U.S. central bank might begin to withdraw liquidity from the financial system before too long by reducing its massive balance sheet.
“One of the two big threats to getting back to maximum employment is actually high inflation,” Powell said during a press briefing, adding that the pandemic was the other. “What we need is another long expansion, like the ones we have been having over the last 40 years.”
Financial markets took the shift in the Fed’s rhetoric in stride, with investors betting that the central bank can pull off a proverbial soft landing of the economy — reining in rapid price increases with gradual increases in interest rates that don’t materially damage gross domestic product. Stock prices posted the biggest rally since 2020.
“The first step for the Fed is open-mouth operations: They are talking tough,” said Scott Brown, chief economist with Raymond James Financial (NYSE:RJF). “The Fed is seeing inflation broadening out and people are hearing about inflation on the nightly news — inflation, inflation, inflation. The Fed is worried about that.”
They’re not the only ones worried. Faced with sagging opinion polls and growing voter concern about rapid inflation, President Joe Biden has recently taken to acknowledging the damage being done by higher prices while still talking up the strength of the economy.
Some economists have their doubts about the Fed’s ability to keep the expansion going, arguing that it’s been slow off the mark in shifting its focus to an inflationary threat that has been steadily building throughout the year.
“The Fed had fallen behind the curve in terms of its rhetoric and actions in regard to containing the threat from inflation,” said Mark Vitner, a senior economist at Wells Fargo (NYSE:WFC). “In the past, it has proven very difficult to slow inflation when the economy is at full employment and real GDP is growing faster than its potential. That is where we will be in 2022.”
Powell denied that the timing of his pivot had anything to do with Biden’s decision to renominate him for another four-year term, telling reporters that he had begun putting it in place before the president made his announcement on Nov. 22.
The shift by the Fed comes after months in which Powell had insisted that the rise in inflation was transitory and driven by supply-chain bottlenecks that would fade with time. The Fed on Wednesday drove a stake in the transitory rhetoric, dropping it completely from its post-meeting statement.
Powell said the Fed still sees inflation coming down next year and beyond — and the forecasts that policy makers released on Wednesday bear that out. But to bring that about they now see a markedly more rapid pace of interest-rate increases than they projected just two months ago.
While the Fed statement referenced the risk to the economy from new Covid-19 variants, Powell played down the potential impact of omicron, arguing that growth was strong and that vaccinated Americans were learning to live with the virus.
Powell maintained that the U.S. could well reach maximum employment next year when policy makers are projecting that they will start lifting interest rates from zero. Unemployment has fallen rapidly, though at 4.2% for November it is still above the 3.5% mark prior to the pandemic.
He acknowledged that the labor market may not fully return to the stellar levels that prevailed before Covid-19 struck, particularly when it comes to workforce participation. Some Americans probably have dropped out of the labor force for good, including aging baby boomers whose retirement savings plans have benefited from a surging stock market.
“We’re not going back to the same economy we had in February of 2020,” Powell said.
Indeed, he said the Fed was keeping a close eye on wages lest they begin rising so rapidly that they feed into already too high-inflation.
“We would not in any way want to foreclose the idea that the labor market can get even better,” the Fed chair said. “But again, with inflation as high as it is we have to make policy in real time, we’ve got to make that assessment in real time.”
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Powell Declares Inflation Big Threat as Fed Signals Rate Hikes