Monetary Policy & Inflation | US
The Fed is Failing
- By Bilal Hafeez
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- 1 min read
The Fed’s failure is neither that rates volatility has picked up nor that equity markets fell last week. Rather, it is that they cannot persuade the market that Fed policy will remain loose to generate inflation and improve income inequality. Indeed, just as inflation expectations picked up, bond yields have risen sharply, and the market is almost pricing the first Fed hike in 2022.
This was not meant to happen. The Fed introduced its average inflation target (i.e., allow inflation to overshoot) with much fanfare in August last year. Yet, the Fed’s own inflation forecasts as well as consensus are expecting no inflation overshoots (Chart 1). This means average inflation is likely to fall below the magical 2% level. It is ironic that the Fed has systematically failed to meet its inflation target ever since it got more explicit about doing so. And markets are calling the Fed’s bluff and pricing hikes to say that the Fed is not serious about creating inflation.
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The Fed’s failure is neither that rates volatility has picked up nor that equity markets fell last week. Rather, it is that they cannot persuade the market that Fed policy will remain loose to generate inflation and improve income inequality. Indeed, just as inflation expectations picked up, bond yields have risen sharply, and the market is almost pricing the first Fed hike in 2022.
This was not meant to happen. The Fed introduced its average inflation target (i.e., allow inflation to overshoot) with much fanfare in August last year. Yet, the Fed’s own inflation forecasts as well as consensus are expecting no inflation overshoots (Chart 1). This means average inflation is likely to fall below the magical 2% level. It is ironic that the Fed has systematically failed to meet its inflation target ever since it got more explicit about doing so. And markets are calling the Fed’s bluff and pricing hikes to say that the Fed is not serious about creating inflation.
The other failure is that for all the talk of higher incomes and savings for US households since the onset of the COVID pandemic, there is a clear distributional dimension to the gains. The rich, male and college-educated have seen their finances improve, while other groupings have not (Chart 2). The employment picture is similar, with the biggest reversion to pre-COVID levels seen among whites rather than blacks or Hispanics (Chart 3).
The Fed, then, needs to decide whether it is serious about creating inflation and improving the distributional impacts of policy – otherwise the markets will do it for them.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)