With few expecting the Federal Reserve to begin tapering when it announces the outcome of its latest policy deliberations on Wednesday, the focus of economists and market participants will be not only on hints of when and how such a taper may come but also on the challenges Chair Jerome Powell is likely to face in maintaining harmony within an increasingly divided Federal Open Market Committee.
The outcome of both will depend on specifics related to the economy, inflation and asset prices.
A new Covid-related cloud has settled over U.S. economic growth prospects. Its cause is the delta variant which, as in many other countries, is proving much more infectious than other iterations, especially among the unvaccinated population.
Fortunately, and consistent with the experience of the U.K., which has tended to lead the U.S. on Covid issues by four to eight weeks, the notable rise in Covid cases is not being accompanied by a sharp increase in hospitalizations and deaths, though the risk of long Covid is a concern.
Fed officials will need to decide on the extent to which this new Covid cloud undermines what had been encouraging and often-repeated upward revisions in their growth projections.
The focus will be on the service sector and involves both demand and supply dimensions: namely, the extent to which consumers may hold back their recovering engagement in travel, leisure and hospitality in particular; and the extent to which labor force participation remains below what is desirable.
Data Debate
The Fed's inflation discussion will take place against the backdrop of more data points that suggest parts of the significant increase in the whole range of price indicators — the consumer index, the producer price index and the personal consumption expenditures price index, or PCE, the Fed's favorite measure — may not be as "transitory" as the top-level conviction has been signaling again and again.
It may force a more focused internal discussion on what exactly transitory means and, even trickier, whether the central bank should share more operational details with markets.
Unfortunately, the analysis may continue to rely excessively on models, whose efficacy is inadvertently weakened by continuing structural changes in the economy and financial market distortions, instead of comprehensive company-based information on cost developments and pricing behavior.
Then there is the extent to which the continuous rise in asset prices is encouraging excessive risk-taking, bubbles and unsettling future financial volatility. As has been routine now, the FOMC will be meeting on the heels of yet another set of records in a host of financial metrics, including stock prices, liability-related corporate activities, margin debt, retail sector participation and more.
And even though these have not been as troubling as the time the repo rate exploded under the Fed's nose to above 9% and required yet another set of emergency interventions, central bankers have had further reminders — this time from the bond market — that their usual dashboard no longer captures well the underlying state of market functioning.
More Fed Forecasts
I suspect that, when judged by its statement on Wednesday and the press conference that follows, the Fed will punt on all three issues.
