The central bank’s pullback has sparked jitters in financial markets, with the benchmark S&P 500 stock index in September recording its worst month since March 2020. The danger of persistently higher inflation and the prospect of the Fed slowing the economy by hiking rates in 2022 will also pose political peril for President Joe Biden and the Democrats in an election year, where they hope to be able to point to a robust recovery.
“The training wheels are kind of off for the economy,” said Michael Feroli, chief U.S. economist at JPMorgan Chase, the country’s biggest bank. “If the party’s going to go on, the Fed’s got to let it go on.”
That’s not likely to happen for much longer. Powell acknowledged at a conference on Wednesday that inflation pressures are likely to continue into next year, even as he expects them to eventually ease. The Fed chair said he found it “frustrating to see the bottlenecks and supply chain problems not getting better — in fact at the margins apparently getting a little bit worse.” On Friday, the government reported that a key measure of inflation closely monitored by the Fed rose to another 30-year high.
In the depths of the pandemic last year, both Powell’s Fed and Congress took unprecedented action to shore up businesses, households and financial markets — pumping trillions of dollars into the economy to fill gaping revenue holes and facilitate cheap lending. The Fed has continued to buy a staggering $120 billion a month in government securities to keep rates low.
The speed and force of the response have worked. U.S. growth is expected to exceed 5 percent this year, its fastest pace in decades. But the coronavirus still looms in any forecast, and the threat of rising cases as the weather gets colder could dampen growth, given that there’s little expectation of more of the kind of short-term bursts of aid passed by Congress over the past year and a half. Even the sweeping legislative packages that lawmakers are debating on Capitol Hill now contain mostly measures that would be spread out over a period of years.
“We did have the perfect confluence of tailwinds” boosting the economy earlier this year when everything seemed to be reopening amid widespread vaccinations, bolstered by relief checks and other forms of aid, said Julia Coronado, a former Fed economist and president of MacroPolicy Perspectives. “Now that’s all in the rearview mirror.”
Senior White House economic advisers will not publicly call on Powell to maintain ultra-easy money policies as Washington suffers through another round of fiscal follies, including the possibility of a debt limit scare sometime in the middle of October. But they are privately eager for Powell, who would like to be renominated for a second term as Fed chair later this year, to err on the gentler side, given that the unemployment rate is still elevated at 5.2 percent, while millions of out-of-work Americans are staying on the sidelines altogether.
Joe Brusuelas, chief economist at middle market consulting firm RSM, said Powell has a fine line to walk: Interest rate hikes aren’t ideal for the White House as the midterm elections approach, but heightened inflation figures well into next year could create a different set of worries — suggesting the need to tighten up at least a bit.
“Inflation, while it has probably peaked, is going to remain elevated for the next two years,” he said. “The Fed can’t ignore that.”
Powell has said the Fed expects to start slowing its bond purchases in November and is aiming to stop them entirely by the middle of next year, which could set up a rate increase in the second half of 2022. By that time, the central bank will have a much firmer handle on how supply-chain distortions are spurring price increases across the economy.
“These [supply-chain] effects have been larger and longer-lasting than anticipated, but they will abate,” the Fed chief told lawmakers this week.
The outlook could brighten if the pandemic begins to fade and the economy is able to stand more firmly on its own, cushioning markets from the gradual removal of Fed support and easing production delays. Stocks perked up Friday in the wake of news from pharmaceutical company Merck that its experimental pill aggressively reduced the chances of being hospitalized or dying from Covid.
“As the economy strengthens, Washington becomes less important,” said Richard Bernstein, founder of investment firm RBA.
