Gradual decline, doubts about “transient” inflation and “financial stability risks” due to “valuation pressures on housing markets”: some members of the Fed are getting a little nervous



“Supply disruptions and labor shortages may persist longer and may have larger or more persistent effects on prices and wages than they currently assume.”

By Wolf Richter for WOLF STREET.

Fed officials admitted that they had largely underestimated the surge in inflation, with growing doubts about its “transient” nature, given shifts in inflation dynamics, including ” labor force ”, supply constraints, wage increases and skyrocketing demand. These factors could have a more “lingering” impact on inflation, according to the minutes of the FOMC meeting released today.

The gradual reduction in asset purchases could start earlier than expected at the previous meeting. The boom in the real estate market, fueled by “low interest rates”, is raising concerns about “risks to financial stability”. And reducing mortgage-backed securities purchases “faster or sooner than Treasury purchases” is officially on the table “in light of valuation pressures in housing markets.”

So here are some salient gems of the minutes of the FOMC meeting.

Reduced asset purchases.

  • Tapering may begin “a little earlier than expected”, in light of the incoming data – a view held by “various participants”.
  • It is “important to be well positioned” to decrease “in response to unexpected economic developments,“as the inflation discussed throughout the minutes, or”the emergence of risks,Such as the risks of financial stability, mentioned later in the minutes.
  • “Several participants saw benefits” in reducing MBS purchases “faster or earlier than Treasury purchases in light of the pressure on valuations in housing markets. “
  • “Several participants” noted “that low interest rates are pushing up house prices and that valuation pressures in housing markets could pose risks to financial stability.”

High demand vs. “labor shortage” and supply constraints.

The term “labor shortage” was mentioned five times in the minutes, along with material shortages, supply disruptions and production bottlenecks. The “participants” viewed these factors “as limiting the expansion of economic activity this year”.

A wide range of industries in participants’ districts reported that these constraints and shortages, including labor shortages, “limited the ability of businesses to meet demand.”

Companies have responded to this mix of high demand and shortages in a variety of ways, including “increasing wages to attract and retain workers” and “raising prices”.

The difficulty in hiring workers likely reflected “factors such as early retirements, concerns about the virus, childcare responsibilities and the expansion of unemployment insurance benefits”, which “were making people less able or less inclined to work in the current environment ”.

“Many participants felt that labor shortages put upward pressure on wages or prompt employers to provide additional financial incentives to attract and retain workers, especially in low-wage jobs. “

“Participants expected labor market conditions to continue to improve, with labor shortages expected to ease through the summer and fall.”

In their discussions about inflation.

Participants, surprised by the magnitude of the rise in inflation, “attributed the upside surprise to more widespread supply constraints in product and labor markets than expected and to a larger than expected increase in consumer demand when the economy reopens “.

Participants noted that many businesses in their districts “reported that higher input costs put upward pressure on prices.” And participants “generally expected inflation to subside as the effect of these transient factors wears off.”

“But several participants noted that they expected supply chain limitations and input shortages to put upward pressure on prices next year.”

“Several participants noted that, during the first months of the reopening, uncertainty remained too high to accurately assess how long inflationary pressures will be maintained.”

Doubts about “transitory” inflation arise.

“Some participants felt that supply chain disruptions and labor shortages made it difficult to assess progress towards the Committee’s goals and that it was uncertain how quickly these factors would dissipate. “

“As a result, participants rated the uncertainty around their economic projections as high.”

“A substantial majority of participants felt the risks to their inflation projections were on the upside due to concerns about supply disruptions and labor shortages. may persist longer and may have larger or more persistent effects on prices and wages than they currently assumed.

“Several participants expressed concern that long-term inflation expectations could reach inappropriate levels if high inflation figures persist.”

So this is it.

Amid inflation that has taken the Fed’s inflation forecasts out of breath and inflation dynamics that are inherently persistent, like inflation expectations, doubts arise even within this Fed that this surge inflation will go away on its own, while the Fed continues to suppress short-term interest rates to near zero, and while the Fed continues to suppress long-term interest rates by buying securities Treasury and MBS. And the Fed is signaling that change is underway.

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