By Howard Schneider
WASHINGTON (Reuters) – Federal Reserve officials meet this week faced with ongoing tension between their two main goals, as inflation rises faster than expected even with millions of Americans still unemployed more than a year after the onset of the coronavirus pandemic.
In a new policy statement and economic projections due on Wednesday, the U.S. central bank is expected to point to continued strength in the economy and acknowledge the first conversations among its policymakers about when and how fast to pare back the massive bond-buying program launched in 2020 to help battle the recession triggered by the pandemic.
Policymakers will also update their views on when the Fed should raise its benchmark short-term interest rate from the current near-zero level, with markets focused on whether the core group of central bank officials shift a first expected rate increase into 2023 from 2024, where it stood as of the last round of projections in March.
The Fed will be treading a fine line, having made a strong commitment to use its monetary policy tools to regain the jobs lost to the pandemic but aware of rumblings within its ranks over the possibility that the economy has healed faster and inflation rebounded more forcefully than expected – albeit with fewer workers involved.
(Graphic: Labor market index – https://graphics.reuters.com/USA-ECONOMY/LABORINDEX/xlbpgkdropq/chart.png)
While policymakers expect the current friction to dissipate as the complications of reopening the economy, rehiring workers, and restoring supply chains get worked out, the process may take months. If the Fed has misread the post-pandemic economic situation, it will be that much further behind in preparing for faster rises in prices, Donald Kohn, a former Fed vice chair, said last week at an American Enterprise Institute event.
The Fed’s current focus on using loose monetary policy to try to generate ever more employment makes sense with so many people still out of work, Kohn said, but “is not designed to deal with the upside risk on inflation.”
The last months of 2021, with the economy fully reopened and time to work out the kinks, “will be a critical test … to see whether the hypothesis about easing supply constraints will be enough to keep inflation under control,” Kohn said.
This week’s two-day meeting is likely to mark the start of what the Fed hopes will be a smooth and gradual exit from the policies put in place to fight the pandemic, with its $120 billion in monthly asset purchases eventually reduced and then eliminated over time, followed later by a slow climb in interest rates.
Throughout the pandemic, policymakers have said such a process would take years to complete. Even recent high inflation readings have been seen by most at the Fed as an outgrowth of the economic reopening that would fade on its own without any need for a swift shift away from the wide-open monetary policy being used to support hiring and the incrementally tighter monetary policy, marked by higher borrowing costs, that would be used to slow the economy and keep prices under control.
New economic projections from policymakers, which are due to be released along with the policy statement at 2 p.m. EDT (1800 GMT) on Wednesday, will show how that outlook has been reshaped, if at all, by data that has pulled in two directions in recent months.
In December, the Fed said it would make no moves on any front until the United States had made “substantial further progress” in bouncing back from the pandemic.
Fed Chief Jerome Powell in particular has emphasized the central bank’s new view of maximum employment as a “broad-based and inclusive” concept attentive to whether racial minorities and women, for example, are reaping the benefits of economic growth. Powell is scheduled to hold a news briefing after the release of the policy statement and projections on Wednesday.
(Graphic: Substantial further progress for the Fed? – https://graphics.reuters.com/USA-ECONOMY/FEDPROGRESS/nmovazmdypa/chart.png)
The progress since December has been mixed, and slower than the Fed had hoped. Compared to expectations of job growth of a million or more per month, the increase in nonfarm payrolls has averaged 460,000 per month in 2021. Overall, the economy has regained only about a quarter of the jobs lost as of December; the share of the adult population in a job, a measure many policymakers see as a central measure of economic health, is still more than 3 percentage points lower than before the pandemic, with only modest improvement since late last year.
Yet since the Fed’s last forecasts in March, overall economic growth may have accelerated, and some policymakers estimate it is already back to its pre-pandemic level. Fed Vice Chair Richard Clarida said recently that gross domestic product growth could top 7% this year – a figure consistent with the 6.9% median view of private forecasts in a recent Reuters poll.
(Graphic: Fed vs. private 2021 GDP outlook – https://graphics.reuters.com/USA-FED/OUTLOOK/rlgpdbnxzpo/chart.png)
A boost in the Fed’s GDP outlook would likely mean an improved year-end unemployment projection as well. Accompanied with higher inflation, that could begin to shift the thinking of the central bank in how to manage its flexible 2% inflation target.
Median expectations among consumers for what inflation will look like over the next year rose for a seventh consecutive month to 4% in May, up from 3.4% in April, according to a monthly survey released by the New York Fed on Monday.
Some policymakers have already signaled they feel the monthly bond-buying program has outlived its usefulness and should be reduced soon. And it would only require two Fed officials to change their views about the timing of a first rate hike to begin to shift “liftoff” into 2023.
“For the first time in a while, we are cautious heading into the June Fed meeting this week,” given the possibility of the central bank sounding more strident about inflation and more doubtful about the timetable for tightening policy, ISI Evercore Vice Chairman Krishna Guha wrote this week. “The challenge for the Fed is to show it is implementing” its new, job-focused framework, “not changing it … To the extent there is any information at all in (recent economic) data, it has gone in the direction of a near-term conflict between the Fed’s employment and inflation goals.”
(Reporting by Howard Schneider; Editing by Paul Simao)
