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Inflation, wage data, the Fed’s “passing” narrative challenge | The mighty 790 KFGO

By Howard Schneider

WASHINGTON (Reuters) – Price and wage hikes at a multi-decade high could challenge Federal Reserve officials this week as they try to strike a balance between ensuring inflation containment and allowing the economy to run since the pandemic.

With investors already betting that the Fed will hike rates twice over the next year, at a much earlier and faster pace than policymakers themselves forecast, Goldman Sachs economists have sped up their rate hike call – and by one brought forward all year to July 2022.

Up until then, Goldman economist Jan Hatzius and others wrote that, based on the closely monitored core consumer spending index, they expected inflation to exceed 3% – an inflation rate not seen since the early 1990s and well above that of the Fed sets 2% target.

Aspects of the labor market, particularly the labor force participation rate, are unlikely to have recovered to pre-pandemic levels and are likely to remain below the “maximum employment” promised by the Fed before it hikes rates. But at this point, the Goldman team wrote, Fed officials would “conclude that most, if not all, of the remaining participation weaknesses are structural or voluntary,” and would proceed with rate hikes to ensure that inflation remains under control.

“Since the last meeting of the (Federal Open Market Committee) in September, the unemployment rate has fallen further https://www.reuters.com/world/us/us-job-growth-slows-sharply-september-unemployment-rate-falls-48- 2021-10-08, the average hourly wage and labor cost index have risen sharply https://www.reuters.com/article/idCAKBN2HJ1N8?edition-redirect=ca, inflation has remained high, “they wrote, making the claim of Fed questions that inflation will pass on by itself without using a rate hike to tighten credit terms and curb corporate and household buying.

BREAK-IN SCHEDULE

The Fed meets this week and will issue a new policy statement on Wednesday at 2 p.m. (1800 GMT), followed by a press conference at 2:30 p.m. (1830 GMT) by Fed Chairman Jerome Powell. Officials are expected to approve plans to reduce their current $ 120 billion monthly bond purchases, which they would phase out entirely by the middle of next year – a first step away from core policies introduced in early 2021 to address the economic impact to fight the pandemic.

Fed officials have tried to separate that decision from their eventual and more momentous call for when interest rates should be increased. The benchmark for a rate hike was set last year when the Fed said it would not raise its policy rate until the economy returned to maximum employment and “inflation has risen to 2 percent and for some is on the way, 2 percent to be exceeded moderately “. Time.”

At the time, policymakers thought they had enough time to eventually phase out the low-risk bond purchases. Even as prices began to rise earlier in the year, Fed officials argued that the rapid pace would prove “temporary” and would not push them to hike rates.

However, the schedule can collapse on them.

Goldman economists are now seeing a “seamless” transition from bond taper to rate hikes over the next year, a view that is in line with the view currently prevailing in the interest rate futures markets.

According to the CME Group’s FedWatch tool (https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html) trading in futures contracts for federal funds now implies a probability of more than 65%, that the Fed will hike interest rates in June just before the taper is expected, with a second hike expected in November. A month ago, the interest rate market indicators signaled a less than 20 percent probability of an interest rate hike in early June and a comparatively negligible probability of two interest rate hikes in the next year.

TRANSITIONAL WORK ‘NOT AGED’

It can be a confusing moment when it comes to inflation. Initially due to expected temporary supply disruptions and an increase in consumer spending on goods that are sometimes difficult to find, the pace of price increases has remained longer than expected.

Not only is goods inflation expected to ease in the next year, but it is actually expected to reverse in a round of falling prices. However, the cost of services is expected to make up the difference, especially if a recent increase in employee compensation proves persistent.

The rise in wages and benefits will pose a particular challenge for the central bank to determine whether employees are getting better paid because productivity is increasing or because the pandemic has thrown labor markets and the number of available workers out of whack.

One would be seen as a positive development; the other as potentially even higher inflation risks.

“All of this brings Powell to the hot seat at the November meeting to a far greater extent than it seemed likely a few weeks ago,” as he tried to balance a committee roughly even between those who are ready, those Raising rates next year and those willing to raise rates Show more patience, wrote Krishna Guha, ISI vice chairman at Evercore.

“None of this proves that the temporary thesis will ultimately be wrong,” he wrote, but “the tests of believing that excessive inflation is likely to prove temporary have not aged well”.

(Reporting by Howard Schneider; Editing by Dan Burns and Daniel Wallis)

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