Fed Chair Powell retires ‘transitory’ inflation view

The US dollar rose sharply across the board on Tuesday after a surprisingly hawkish set of remarks from chair of the Federal Reserve Jerome Powell.

Speaking in front of the Congressional committee, Powell warned over the risks of rising US prices, noting that the threat of higher inflation had grown and saying that it was time to ‘retire the word transitory regarding inflation’. This is a very significant development given that the Fed has been highly reluctant to acknowledge that high price pressures were here to stay for longer, instead insisting on using the word ‘transitory’ to express its view that above target inflation was merely temporary. Powell also stated that the FOMC would consider speeding up the pace of tapering in the coming months, and that committee members would discuss this at their next meeting on 14th-15th December.

Investors were very much caught wrong-footed by Powell’s comments. We had said this time last week that the Fed was very likely to announce at its December meeting that it would be speeding up the pace of its tapering from January. Our conviction in this view, and indeed among market participants, had undoubtedly faltered amid uncertainty surrounding the detection of the highly mutated omicron strain of COVID-19. Powell did note that omicron presented a risk to the outlook, although he doesn’t appear overly concerned at this stage, with the news so far seemingly not derailing the Fed’s tapering plans.

As Powell mentioned, we will not know more about the variant for another week to ten days or so, when we should hopefully receive data on the virus’ transmissibility and the efficacy of existing vaccines against the mutation. Some bad news on this front could easily prevent the Fed from tightening policy again later this month, although as things stand it appears that policymakers are keen to end tapering and start hiking sooner rather than later. Futures markets are not fully pricing in the first interest rate hike until June 2022, although we get that impression that the Fed would be keen to begin raising rates before then, provided no additional lockdown restrictions are required in order to combat the omicron variant.

Markets reacted as one would expect, with the dollar at one stage up over one percent against both the euro and the pound on Tuesday, albeit most of these gains have since been reversed. While the Fed is clearly concerned with rising inflationary pressures and would ideally end tapering in Q1 2022, with hikes to follow soon after, the uncertainty surrounding omicron means that this is far from guaranteed. Cases of the highly mutated strain have been cropping up around the world, with 20 countries now reporting official confirmed cases. There are, however, reasons for optimism, particularly given that cases of the variant have so far seemingly only resulted in mild symptoms, with no reported hospitalisations or deaths with those carrying the strain. The mutation could be everything or nothing to worry about, but until we get more information there's no way of knowing for sure. In such an uncertain environment, we continue to favour the safe-haven currencies, which have comfortably outperformed most of their peers in the past week or so.