Inflation has clearly been on the rise this year, as seen in the economic statistics and at the local store and gas station. Inflation matters, and not just because of the higher cost of living. For investors, inflation signals a potential change in Federal Reserve policy that could impact markets. If inflation becomes ‘persistent’, then the Federal Reserve may be forced to adopt an ‘inflation fighting’ policy, reducing some of the liquidity and low interest rates that have fueled economic growth and the run up in stocks. On the other hand, if inflation is ‘transitory’ then it may come back to normal levels without significant changes to Federal Reserve policy. For months Chairman Powell has been pushing the narrative that inflation is simply transitory, a result of the year over year comparisons against a virus induced recessionary 2020. This week, Chairman Powell admitted to Congress that inflation was indeed persistent, signaling that the Federal Reserve may be forced to more quickly pivot away from economic stimulus and toward inflation fighting.
Earlier this year, during one of the more frustrating press conferences regarding inflation, Chairman Powell was asked about his definition of Transitory. His helpful response, “not persistent”. I believe that the reporter was seeking a timeline – how many months would the Federal Reserve put up with high inflation before taking action. It appears that we now have an answer – at least a clearer one. During testimony before congress this week Powell stated, “At this point, the economy is very strong and inflationary pressures are higher, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases…perhaps a few months sooner”. “I expect that we will discuss that at our upcoming meeting.” It appears that Powell is pivoting to a stronger response to inflation.
Powell may be wrapping up his bond purchases, but the only thing that investors are getting is a lump of coal. The stock market seemed surprised by Powell’s statement and sold off this week by 2.8%. That said, it is important that the Federal Reserve begin to fight inflation and will likely be the right long-term answer for the economy. Inflation peaked at 6.2% for the month of October. To delay any longer would risk allowing inflation continuing to rise and undermine confidence in the Federal Reserves willingness to tackle inflation.
So, what is the answer to the inflation question? Is it persistent or transitory? It appears persistent and the Federal Reserve will be forced to take inflation fighting seriously in the coming months. If they change policy to reduce bond buying as advertised, we should see inflation numbers coming down in the coming months. The stock market may be in for additional volatility as this transition occurs, especially as the Federal Reserve changes policy from their current wide open throttle support of the economy.