Are we in the middle of an inflationary cycle or just an adjustment phase? That’s the question investors are trying to answer. The Federal Reserve announcement on June 16th is sending somewhat mixed messages.
The Fed had hinted this may be more situational than foundational and described inflation on several occasions as transitory. Yet, the Fed raised its expectations for inflation this year from 2% to 3.4%.
In May, consumer prices had its largest increase in more than a dozen years. As employers continue to have difficulty hiring workers, wages are increasing which puts more pressure on businesses, especially small businesses, retailers, restaurants, and those in trades. Without the ability to absorb wage increases, many businesses are forced to raise prices to accommodate increased payroll.
Even with supply chain problems, the US economic recovery has picked up steam in the past few weeks. While noting the increase in prices, the Federal Reserve said to “anticipate facing cost increases and charging higher prices in coming months.”
The Federal Open Market Committee left its benchmark for short-term borrowing rates near zero but signaled it may need to raise rates earlier than had been expected. In March, the Committee said it foresaw no rate increase until at least 2024. The new guidance may include two hikes in 2023.
James McCann, Deputy Chief Economist at Aberdeen Standard Investments, told CNBC: “This change in stance jars a little with the Fed’s recent claims that the recent spike in inflation is temporary.”
Fed Chairman Jerome Powell said the reopening from the COVID pandemic raises the possibility that inflation could edge higher and be more persistent than earlier anticipated, but he also said his expectation is that “these high inflation readings now will abate.”
While maintaining current interest rates, the Fed continues its accelerated buying of Treasuries and mortgage-backed securities. They are currently spending more than $120 billion per month. This puts downward pressure on long-term costs for borrowing to, hopefully, encourage more investment and job growth.
While the Fed’s buying of mortgage-backed securities has kept interest rates low, some analysts say it’s fueled higher real estate prices. The real estate market has been red-hot this year, but there are concerns that cause some analysts to start using the B-word: bubble.
“Real estate prices around the world are flashing the kind of bubble warnings that haven’t been seen since the run up to the 2008 financial crisis, according to Bloomberg Economics.” – Edna Curran in Bloomberg
The Fed’s June announcement certainly won’t dampen consumer fears over inflation.
A new poll by Monmouth University released on the same day showed that 70% of Americans are worried about inflation especially in light of spending increases in the Biden administration. While the poll showed 93% of Republicans are concerned about the current administration’s spending, 70% of Independents and a majority of Democrats (55%) also expressed spiraling inflation.
While the Fed policymaker’s noted that indicators of economic activity and employment have strengthened in Q2, they also recognized that inflationary pressures have mounted much faster than expected.
