The venerable chair of the U.S. Federal Reserve, Jerome Powell, has pledged to make the economy great again whilst playing down the risks of persistent inflation at an IMF panel yesterday. Powell suggested that any present recovery in the U.S. economy was not yet complete and that the Fed would continue to support it through continued stimulus despite growing concerns over inflation.

In fact, the Fed Chair strongly pushed the view that rising inflationary pressures was solely transitory and that he expects inflation to dip in 2022 back towards the central bank’s guideline rate at the 2% mark. This is even though much of the present inflationary pressures are commodity driven and not consumer demand-pull inflation.

Subsequently, you would be forgiven for asking what the Fed Chair is attempting to achieve with such a mixed message on inflation, growth, and interest rates. The reality is that Powell is using the expectations channel to attempt to play down the need for monetary action by the central bank. Economic participants form their forward expectations around a range of factors but statements by the Federal Reserve are relatively key.

The real hint within the Fed’s recent messaging is talk of the central bank possessing appropriate tools for handling any significant inflationary pressures. In reality, this is a thinly veiled hammer referring to an increasing Federal Funds Rate (FFR) and potentially a balance sheet taper. However, neither option is palatable for the central bank given the overall risk to equity markets.

Any such monetary policy change would potentially cause a sharp flow of funds away from equities and this could see a significant market rout. This is obviously something that the Fed is desperate to avoid and resembles the act of attempting to slowly let air out of an inflated balloon.

Subsequently, the Federal Reserve is facing the biggest challenge to its guidance over the economy since the GFC. The massive expansion of the broad money supply was always going to lead to persistent inflation but not necessarily persistent economic growth. This is the very definition of stagflation and something I believe the country will face over the long term.

Ultimately, the central bank faces a tough raft of policy choices in the coming year. Either raise rates/taper to start cooling inflationary pressures and cause a devaluation of asset bubbles. Or sit back and watch inflation continue to rise and destroy the purchasing power of millions of regular Americans. Regardless of their policy direction, the overall stagflation risk is real and will require deft handling and courage to avoid which is a skillset I am not convinced exists upon the MPC at present.

Risk Warning: Any form of trading or investment carries a high level of risk to your capital and you should only trade with money you can afford to lose. The information and strategies contained herein may not be suitable for all investors, so please ensure that you fully understand the risks involved and you are advised to seek independent advice from a registered financial advisor. The advice on this website is general in nature and does not take into account your objectives, financial situation or needs. You should consider whether the advice is suitable for you and your personal circumstances. The information in this article is not intended for residents of New Zealand and use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Knight Review is not a registered financial advisor and in no way intends to provide specific advice to you in any form whatsoever and provide no financial products or services for sale. As always, please take the time to consult with a registered financial advisor in your jurisdiction for a consideration of your specific circumstances.

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