US consumer prices jumped by 6.2% in October, their highest level in 30 years! Deteriorating inflation data have pushed markets towards forecasting a faster pace of tapering and a more rapid removal of accommodation in 2022. We expect the Fed to act gradually as Covid remains a major risk and as the Fed would like to see a higher participation rate. The Fed will have a step-by-step approach and a rapid turnaround in strategy is possible. To a greater extent, a high level of debt, a tight valuation of assets, and the huge investments required to move to a low-carbon economy will limit the Fed’s ability to raise rates.
The current high level of inflation is due to very strong demand meeting bottlenecks and shortages. The Covid-19 crisis has been characterised on the one hand by impressive lockdowns and supply-chain disruptions and on the other hand by unprecedented support from governments and central banks. These support measures have aimed to preserve demand and limit long-term damage to our economies. For central bankers and fixed-income investors, the challenge in 2022 will be to predict: (1) the persistence of supply constraints and lockdowns, (2) the sustainability of demand, and (3) their joint effects on inflation and growth. Indeed, it is crucial to determine what conditions will be like on the labour market and what the drivers of inflation will be: costs and/ or strong demand. These points will be decisive in the Fed’s reaction to this more inflationary environment. Rising rates cannot resolve supply-side shocks. In addition, for the Fed, it is appropriate to be “patient” to determine the true state of the economy and to assess potential structural changes.
The inflation that we’re seeing is really not due to a tight labour market, it’s due to bottlenecks and it’s due to shortages and it’s due to very strong demand meeting those.
It is very difficult to predict the persistence of supply constraints or their effects on inflation. Global supply chains are complex.
Our tools cannot ease supply constraints.
The Fed expects inflation to recede by Q2 or Q3 of next year.
According to the Fed, “maximum employment” could be achieved by H2 of 2022. The Fed is calling for patience for a better assessment of the post-Covid macro picture, including the participation rate.