The conversation around monetary policy among market participants has unfortunately revolved around a potential pivot by the Federal Reserve toward reducing rates because of an elevated risk of a recession.
The idea among market participants of a near-term policy pivot with a rate cut is misguided.
But Federal Reserve Chairman Jerome Powell will have the last word. His much-anticipated speech on Friday morning will most likely lay down a marker for where monetary policy will go over the next few years.
Given that the title of the symposium is “Reassessing Constraints on the Economy and Policy,” we anticipate a vigorous discussion around the ability of the central bank to restrain inflation in a timely manner while not causing a recession.
We do not think that is probable, but here we are as central bankers move to act forcefully to keep inflation expectations anchored while not causing too much damage to employment conditions.
In our estimation, the idea of a near-term policy pivot is misguided and most likely represents the last gasp of conventional market wisdom that prevailed from 2010 to 2020. Any idea that policy will return to the pre-pandemic status quo should be politely dismissed.
Rather, policymakers, investors and firms should prepare for a regime change in inflation that will require tighter monetary policy as the central bank lifts the policy rate to 4% by the end of the year and draws down its $8.85 trillion balance sheet.
This will all take place in an economy with tight labor markets, global supply chain challenges, a shortfall in global energy supply and geopolitical tensions.
We expect Powell to use a discussion around a historically tight labor market to dampen speculation of a near-term pivot in policy featuring a rate cut.
We strongly disagree with current market sentiment and call on the Fed to lift the policy rate to 4% by the end of the year before any potential pause in rates.
Once the Fed does pause, we expect it to last for an extended period of time.
The Fed is not alone in the inflation discussion. At the recent European Central Bank monetary policy conference in Sintra, Portugal, the subtext of that meeting was the possible regime change in inflation.
Assumptions that the long period of low inflation will return should be set aside in favor a sober, clear-eyed policy of price stability as the global economy adjusts to the realities of the post-pandemic economy.
While the U.S. economy is not in recession, and we do not believe it will fall into one this year, the impact of inflation will not soon dissipate.
With inflation now permeating the housing sector, which will be difficult to unwind, Powell’s speech on Friday will almost certainly be one to remember and frame the domestic and global economic narrative into the beginning of the next business cycle.