A temporary dilemma
The Fed's view of 'transitory' might be too long.
When the Federal Reserve first introduced the term “transitory” several months ago to describe budding inflation, it seemed typical Fedspeak. Policymakers have long claimed that the disinflationary factors in place before the pandemic (demographics, globalization, automation, etc.) eventually will counter any emerging price pressures. They remain more concerned about avoiding Japan-like economic malaise. But as it has become apparent the U.S. recovery is robust, dismissing inflation is becoming dangerous. Even a temporary spike can have lasting consequences.
It really does come down to the definition of transitory. No one is expecting the Fed to predict the future. Yet its new average inflation targeting framework, which tolerates personal consumption expenditures (PCE) growth above 2% for “some time,” suggests it has a period in mind because it has to select a starting point. So, how far back is the Fed going? If it picks the months just before the pandemic, then “transitory” likely will be shorter than if it chooses, say, 2014.
This makes a difference, especially if the economy starts to boil rather than simmer. Take the labor market. Employment remains well short of prepandemic levels and the Fed wants to wait until it is running hot before acting. But when the stimulus flow ends in fall, we may see some skill-set mismatches and employers struggling to fill positions. Costs from increasing wages often are passed on to the market as price hikes—or they aren’t and company margins shrink. Either could be damaging to the economy.
More to the point is the prevailing narrative that pent-up consumer demand will be exhausted by the end of summer. We don’t think that is likely. It’s true that many Americans have booked themselves silly with vacations, shelled out to renovate their homes and bought tickets to concerts, games and other entertainment. But they can’t spend everything at once. The personal savings rate is high enough to support many months of trips and activities. "Save the date" requests proliferate and demand for some larger purchases, from cars to durables, will have to wait for inventory restocking. Many people have a war chest of money that will last a while.
There is real potential this temporary period of rising inflation will turn into, well, a period. The Fed might need to act before it wants to. It already is considering tapering its monthly purchases of government securities, mentioned in an incredibly hedged sentence in the minutes to its April policy meeting: “A number of participants suggested…it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”
Cash managers and investors will welcome that. Other positive news is that Treasury Secretary Janet Yellen said that when the debt ceiling is hit on Aug. 1, the level the Treasury balance needs to be under will be significantly higher than once thought (potentially around $400 billion versus $150 billion). This means the market won’t lose as much supply. But there is still a lot of money chasing few opportunities, and yields on the front end of the yield curve remain low. It is particularly the case in the tax-free space as stimulus money continues to arrive at the doors of state and local governments. But the main issue is that the overnight markets still are off kilter. We expect the Fed to heavily consider raising the reverse repo facility when it meets in June.
The weighted average maturities of our money market funds remain in target ranges of 35-45 days for government and 40-50 days for prime and municipal.