Mizuho daily – FOMC Jolt, Inflation: A study in unevenness, interaction & dislocation

By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

FOMC Minutes: Minority Jolt

John Stuart Mill, in his book “On Liberty”, presciently alluded to oppression by the majority, as a political system pitfall.

But with all due respect, he might also have been blind-sided by the tyranny of the minority that appears to have come through in this FOMC Minutes. Admittedly, your scribe exaggerates flirting with mischaracterization. But the point is FOMC Minutes’ revelation of minority (“a number”, “some) views delivered a hawkish surprise.

For the record, the Minutes were unambiguous on the need to be defensively dovish, given;

i) “inflation … largely reflecting transitory factors”;

ii) conditions “far from … maximum-employment and price-stability goals”, and;

iii) that the “ongoing public health crisis continued to weigh on the economy”.

And so, there was no perceptible shift in the dovish mood or commitment by the FOMC.

However, allusion to inflation risks and “taper” discussions by a minority appears to have caught the attention of, and as a result caused some concerns in, markets. Specifically, “taper” talks suggestions, with “a number” of participants deeming it “appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases” appears to have been the offending line that sent yields higher and equities lower.

Especially backed by upside inflation concerns, presumably amongst the same group; as “some participants mentioned upside risks around the inflation outlook that could arise if temporary factors influencing inflation turned out to be more persistent than expected”.

The resultant surge in yields (with 10Y yields going towards 1.7%) and lift to USD square with this minority hawkish surprise that overtook the broader dovish message.

But this is merely the gentlest of previews of actual “taper” risks. Point being, EUR merely slipped below 1.22, while AUD lost some traction at 0.78. USD/JPY hardly rose above 109 figure while USD/SGD was bumped up a little higher above 1.33. Everything screamed measured.

And we know from experience that true blue “taper tantrums” are anything but.

In other words, this was a minor(ity) jolt; and ultra doves while jolted were not jilted. But that’s not to say that the debate and uncertainty over inflation outlook is invalidated.

Inflation: A Study in Unevenness, Interaction & Dislocation

In fact, the uncertainty around how disruptive and durable cost-push pressures may be – even selectively spilling over some segments of wages – will continue to be the biggest policy challenge for a world trying to extricate itself from the pandemic.

There are (at least) three dimensions of complexity to assessing real world inflation risks.

First, the unevenness of inflation. Simply put, not all prices (and wages) are rising evenly in this divergent recovery. And this challenges any single point of inflation reference. Critical to this assessment is ascertaining how much of inflation is a monetary phenomenon (from policy), what share reveals demand pick-up and perhaps most pertinently, just how dominant the cost-push factors owing to transitory supply and capacity quirks are.

Second, is the difficulty in predicting the interaction between various price transmission factors and mechanisms. More complex supply chains means that cost shocks can reverberate further and for potentially longer in an uneven recovery.

And finally, the dislocation between inflation and underlying economic fundamentals. In other words, whether prices are an accurate gauge of the economy. This goes to the heart of why so much importance is placed on inflation as an economic indicator.

Point being, cost  push pressures may largely reflect capacity impairment due to the the pandemic’s lingering effect rather  than overwhelming demand recovery from the pandemic. And if indeed this spate of inflationary pressures prove transitory, it may not only be unnecessary to overreact, but perhaps outright deleterious to do so prematurely.

Upshot: Inflation shifts require careful scrutiny demanded to ensure the current brand of cost-push inflation does not perversely foreshadow deflationary impact on demand; as household disposable incomes and corporate profits are eroded at early-stage recovery.

Credit: Mizuho Bank Ltd