“Transitory” Retirement

After months – and months – of reiterating a “transitory” assessment of inflation, earlier this week, Federal Reserve Chairman Jerome Powell surprised investors by suggesting inflation may be more longstanding in nature. But while his concession may offer vindication to those who took issue with the Fed’s longstanding inflation-dismissal rhetoric, businesses and consumers are still paying higher prices regardless of how it’s described. After all, while a rose by any other name may smell just as sweet, inflation by any characterization is just as burdensome – eating into consumers’ wallets and corporate profit margins. Powell’s recognition of more persistent inflationary pressures, however, and, by extension, a potential increased willingness to rollback accommodation comes at the same time the Fed warns of increased economic risk amid the emergence of Omicron.?

Transitory, Not-So-Transitory

Earlier this week, Powell joined Treasury Secretary Janet Yellen to testify on the CARES Act before the Senate Banking Committee and House Financial Services Committee. With many key topics to address, prices – rising prices – rose to the top of the list for discussion. Powell was asked numerous times and in numerous ways about his views on inflation, and at one point was specifically pressed on how long inflation needs to run above the target before it is determined to be “not so transitory.”

Powell was expected to simply reiterate the Committee’s long-standing argument of temporary price pressures due to supply chain disruptions and a still inadequate return of “balance” in the marketplace. Instead, he diverted from the rhetoric, acquiescing that it’s probably a good time to “retire that word.” While stopping short of insisting inflation is more permanent in nature, Powell did essentially admit inflation is no longer “transitory” – or temporary – , opening the door for a potentially more hawkish pathway for monetary policy. “It is appropriate, I think, for us to discuss at our next meeting, which is in a couple of weeks, whether it will be appropriate to wrap up our purchases a few months earlier,” said Powell.

Of course, with the economy still in a nominally fragile state coupled with additional downside risks rising from the lingering threat of COVID-19 and the latest Omicron variant, at least some market participants are left wondering whether or not now is the “appropriate” time for policy makers to increasingly focus on taming inflation. After all, Powell identified the virus as a significant risk to the recovery at the very same appearance on Capitol Hill.

During his prepared remarks, prior to the lively discussion on inflation, Powell said the emergence of the latest COVID-19 variant poses risks to both sides of the central bank’s mandate that includes stable prices and maximum employment: “The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people's willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.” In other words, while the economy currently remains on solid footing and inflation remains elevated, the virus could swiftly and aggressively alter the trajectory of the recovery to the downside.

Unknown

Monetary policy officials have long warned of the underlying risk of COVID-19 and the lingering impact on the pace of the recovery. Recall, the past eleven statements, including the most recent November 3 communication, warned that the trajectory of economic growth first and foremost depends and will continue to depend on “the course of the virus.” Thus, against the backdrop of Omicron as the U.S. heads into the winter flu season, Powell’s latest comments underscore the reality or at least a growing likelihood that a downside risk is realized if and when the virus spreads.?

The “risk,” however, may be significantly reduced this time around. As Atlanta Fed President Raphael Bostic pointed out, lessons learned over the past 20 months will likely help mitigate any future headwinds from Omicron or other future virus strains. Speaking to Fox News, he said, “With each successive variant that's been introduced, the economy has slowed down, but the amount of slowdown has been less.”

Of course, such optimism is predicated on the notion that the latest variant plays out similar to Delta. Recall, despite a rapid rise in cases through the spring and summer months, the emersion of the Delta variant had a relatively muted impact on the momentum in the economy, or at least the policies imposed to stem the spread of Delta had a relatively muted impact.

Powell didn’t discuss specific changes to the current pathway or more broadly the direction of monetary policy in this week’s testimony. Weighing the potential downside risks of the virus, however, relative to the realized upside momentum of inflation, the Chairman appeared to be “siding,” as Bloomberg News described it, with those looking at a faster taper timeline.?

What’s the Risk?

With the newly discovered Omicron variant, investors, consumers, and officials alike are asking a number of questions and raising concerns. Is the virus the biggest risk to the economy? What can the economy withstand if the new variant spreads widely?

While the virus could pose downside risks to hiring and investment and, by extension, the broader recovery, the potential economic impact of Omicron essentially depends more on the policy response than the variant itself. Some officials contend everything and anything must be on the table to combat the latest strain, while other top officials, including the White House, say some of the toughest safety measures initially used at the onset of the crisis will not be needed to curb the spread of the Omicron variant.

Health implications aside, a return to the onerous safety precautions of 2020 could lead to a second-round recession and derail the Fed’s plans for a more rapid return to neutral policy. On the other hand, a minimalist approach to address the Omicron variant is likely to keep the recovery on solid footing and the Fed firmly on a pathway to conclude the taper mid-2022 and begin raising rates by the end of next year.?

-Lindsey Piegza, Ph.D., Chief Economist