It’s official – inflation is no longer transitory

America’s central bank has had a change of heart on inflation, and wants to retire the word “transitory”. John Stepek explains what that means for markets, the economy, and for you.

It’s official: inflation is no longer “transitory”.

The world’s most powerful central banker declared yesterday that it was time to “retire that word”.

Markets promptly fell out of bed – they’re not used to the Federal Reserve talking tough.

So is this it? Are we about to see the big central bank offensive against inflation?

Transitory is out of the door

Here’s what Jerome Powell, boss of the Federal Reserve, America’s central bank, said yesterday about the dreaded word “transitory”: “We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s a good time to retire that word and try to explain more clearly what we mean.”

There’s a pretty obvious nuance here which I feel may have been missed amid all yesterday’s excitement.

Powell is a bit miffed. To some people, when you say something is “transitory”, you mean it won’t last long. But Powell (and other central bankers) have a subtly different take on the word.

When Powell says “transitory”, he’s not referring to a specific period of time. He just means that the inflation will wash over and through the economy, and won’t leave a mark. In other words, he simply means “transitory” in the sense of “not permanent”.

So when he says it’s time to “retire” the word “transitory”, he doesn’t mean he’s now a believer that we’re in a fully-fledged inflationary environment, he just means he doesn’t like everyone taking the mickey out of him every time he says it. Never underestimate the power of ridicule, particularly when directed at those not used to being on the receiving end of it.

Anyway. Powell didn’t just retire “transitory”. He also said that it was probably a good idea to think about “tapering” a bit more quickly. Previously, the current bout of QE - quantitative easing, or printing money to buy bonds – was meant to end in mid-2022, but it looks like they’ll wind it up earlier now.

So overall, the tone was “hawkish” – hence the drop in markets. Everything from the FTSE 100 to the Nasdaq to gold slipped off their respective perches.

No wonder; this is a bit of a slap in the face for markets. You’ve got a new and so far unknown Covid variant doing the rounds, and yet Powell isn’t taking the chance to back down from his recent change of heart on inflation.

Investors have grown used to being the number one concern for the Fed over the past decade. The likes of Ben Bernanke and Janet Yellen treated every 5% dip as though it might trigger a systemic crisis. When it came to the market, they tiptoed around like they were trying to defuse an intricately-wired bomb.

Now Powell is wading in and acting like inflation is a bigger worry than the level of the S&P 500. It’s downright insensitive.

What’s going on?

Investors beware – politics is a fickle business

It’s mostly politics. The US administration under Joe Biden is worried about inflation – and particularly about high petrol prices (to my lovely American readers, that’s what us British people call gas).

Biden faces mid-term elections next year (it’s a wonder anyone gets anything done) and it seems he’s horribly aware of what happened to Jimmy Carter. So he doesn’t want to go into those with people fretting about the cost of filling up their cars, or believing that the administration is soft on inflation.

So he’s co-ordinated a big release from America’s emergency reserves of oil. Which has serendipitously then been compounded by news of a new variant, which hammered the oil price even further.

Meanwhile, this change of political heart gives the Fed all the cover it needs to talk a tougher game on inflation.

However, there is a big gap between talking a big game and actually acting on it. First, bear in mind that inflation is sitting around 6% and the Fed is simply talking about ending emergency monetary policy a bit earlier than planned. That’s still quite far behind the curve.

Secondly, I suspect – it’s a hunch more than anything else, but I think it’ll be borne out – that inflation may well hit a temporary peak fairly soon, mostly because of base effects and because nothing goes up in a straight line.

With Powell and Biden both talking tough now, that gives fuel for Biden to say that he’s tamed inflation in the run up to the 2022 mid-term elections.

But how much more can Powell do beyond “jawboning”? Inflation might be the big political worry today, but that’s because it’s been in the headlines and because petrol prices have been going up. If you think a 20% drop in the S&P or Nasdaq won’t shift the tone pretty damn quickly, then I’d be curious to hear your reasoning, put it that way.

In short, I imagine Powell still has the market’s back. It will just need to make him prove it. And there will no doubt be “jawboning” in the other direction if it looks as though this squall in the markets is going to turn into something – forgive me – less transitory.

Until tomorrow,

John Stepek

Executive editor, MoneyWeek

Recommended

State pension errors – why tens of thousands of mothers could be missing out on millions in state pension payments
State pensions

State pension errors – why tens of thousands of mothers could be missing out on millions in state pension payments

LCP launches Mothers Missing Millions campaign amid DWP state pension errors.
3 Dec 2022
The top funds to invest in now
Funds

The top funds to invest in now

As market volatility continues, here are the top funds, stocks and investment trusts investors are putting their money into, according to one investme…
2 Dec 2022
The best places to live in the UK – and how much they will cost you
House prices

The best places to live in the UK – and how much they will cost you

Thinking of moving? Here are the best places to live in the UK and how much they will cost if you are buying.
2 Dec 2022
The pros and cons of smart meters – should you switch?
Personal finance

The pros and cons of smart meters – should you switch?

A smart meter can help you keep tabs on your energy usage, but is it better than a regular meter? We take a look at smart meters vs regular meters.
2 Dec 2022

Most Popular

Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022
Fan heater vs oil heater – which is cheaper?
Personal finance

Fan heater vs oil heater – which is cheaper?

Sales of portable heaters have soared, as households look to cut their energy costs. But which is better: a fan heater or an oil heater? We put them t…
21 Nov 2022
UK house prices fall at their fastest pace since 2020
House prices

UK house prices fall at their fastest pace since 2020

UK house prices fell 1.4% in November, their biggest fall since June 2020.
1 Dec 2022