The ‘Powell Pivot’ Fails to Raise Inflation Expectations

January 30, 2020

Source: Bloomberg Source: Bloomberg

When managing interest rate policy, Federal Reserve (Fed) Chair Jerome Powell has regularly emphasized the importance of inflation and inflation expectations. Even in the midst of an extended monetary tightening cycle in 2018, Chair Powell suggested well-anchored inflation expectations made a “win-win outcome possible, by giving the Fed latitude to support employment when necessary without destabilizing inflation.” The Fed used that latitude to implement a quick U-turn in monetary policy at the start of 2019. The so-called “Powell Pivot” would ultimately lead to three consecutive quarter-point rate cuts last year, despite U.S. labor market conditions remaining the strongest in over 50 years.

This week’s chart compares the Fed’s primary policy setting tool, the overnight federal funds target  rate, to one of the Fed’s favorite future inflation gauges — the 5-year, 5-year forward inflation expectation rate. The forward-looking inflation rate measures inflation expectations beginning five years from now and extending five years from that date. Fed policymakers prefer this forward-looking gauge because it eliminates some of the short-term noise created by more volatile food and energy prices in the Consumer Price Index.

Key Takeaway

The Fed’s shift to easier monetary policy did turn out to be a win-win for equity and bond market investors but has yet to deliver its desired impact for higher inflation and inflation expectations. Fixed income investors appeared to shrug off last year’s rate cuts, with forward inflation rates now the lowest since mid-2016. With investor expectations so influenced by persistently low inflation, the biggest risk for financial markets today is concerted global central bank efforts finally succeeding to let the inflation genie out of the bottle. 





Tags: Federal Reserve | Interest Rates | Inflation | Federal Funds Rate | Monetary policy | bond market | Equity market

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