As Omicron spreads, Jerome Powell is in the hot seat

As Omicron spreads, Jerome Powell is in the hot seat

In June last year, Federal Reserve chairman Jerome Powell held a two-day meeting with his top colleagues. The first wave of COVID-19 receded, and some companies started reopening after the closings that were enacted at the beginning of the pandemic. But the unemployment rate was still 13.3 percent, and in the past three months nearly twenty million workers had lost their jobs or were given leave. Powell and other members of the Fed’s main policy-making committee believed the recovery was going to be a long, slow proposition. Their median forecast was that the unemployment rate would be 6.5 percent in the fourth quarter of 2021 and 5.5 percent in the fourth quarter of 2022.

How did these predictions turn out? On Friday, the Ministry of Labor announced that the unemployment rate had fallen to 4.2 percent in November. Not only is the unemployment rate significantly lower than predicted by Powell and his colleagues; it’s already way below what they thought would be in a year. And all the indications are that there are still plenty of vacancies. On the last day of September, the last date the Labor Department released figures, there were 10.4 million job vacancies across the country, close to a record high. With many vacancies, the number of new jobless claims has fallen sharply. A few weeks ago it hit its lowest level since 1969: one hundred and ninety-nine thousand. Last week’s value was a little higher, but not by much.

This is good news for America’s workers who are finally having some leverage over employers. It also suggests that the Fed’s decision at the start of the pandemic to cut short-term interest rates to zero and pump more than a hundred billion dollars of freshly minted dollars into the bond markets every month succeeded the economy through some very dark times to bring times. But the resilience of the economy during the pandemic also left Powell in an awkward position. At the June 2020 meeting, he and his colleagues predicted that the inflation rate would now be below two percent. In the twelve months to October, the consumer price index rose 6.2 percent, the highest increase since 1990.

Some observers, including former Treasury Secretary Lawrence Summers, have been accusing the Fed for months of reacting too passively to rising inflation and warning of a possible wage-price spiral. Republicans now blame Joe Biden for higher prices, even though his policies had very little to do with it.

After Powell long held off critics, arguing that the rise in inflation was a “transitory” product of supply disruptions in certain parts of the economy, Powell abruptly changed his tone last week. While admitting that the Omicron variant carries “downside risks” to employment and spending, he told the Senate Banking Committee that “the economy is very strong and inflationary pressures are high”. He also said that “probably a good time to retire” is the word “temporarily”. The head of the Fed and his colleagues will meet next week for their final meeting in 2021. Powell said it would be “appropriate” to discuss another move to remove some of the monetary stimulus they applied for. in Fed parlance – “speed up the rejuvenation”. Such a move could pave the way for rate hikes in 2022.

A cynical observer might suggest that Powell waited until Biden had nominated him for a second term – a decision the president announced shortly before Thanksgiving – before issuing the warning of inflation and a possible tightening of Fed policy. Whether that is true or not, the 68-year-old former private equity manager now faces the toughest challenge a Fed chairman can face: trying to change policy direction and bring about a soft landing for the economy, without causing a financial crash or a recession. Two of his three predecessors – Alan Greenspan and Ben Bernanke – spectacularly failed to achieve this feat. The Dow was up 600 points on Monday morning, suggesting investors are not too concerned about re-performance. But with the market trading at exceptionally high levels, a break on Wall Street could easily feed itself. And of course, Powell also has to worry about Omicron.

The new variant, which has now been confirmed in at least seventeen countries, is causing great uncertainty about the economic outlook. Last summer, after the introduction of the delta variant, both employment growth and GDP growth slowed sharply at times. Should Omicron prove more virulent than Delta, it could have an even bigger economic impact, although a return to widespread shutdowns currently looks unlikely. Some Fed officials also fear the new variant could exacerbate global supply chain disruptions and fuel further price hikes for items that are already hard to find. The risk is that Omicron “could add inflationary pressures in areas of high demand,” John C. Williams, president of the New York Fed and vice chairman of the Federal Reserve’s Open Market Committee, told the Times last week.

With all these countercurrents, it seems sensible for the central bank to keep its options open. A longtime Fed observer I spoke to said Powell did that last week, making his restrictive comments on inflation and accelerating the rejuvenation. “By throttling early, the Fed can increase its optionality until 2022,” said Tim Duy, US chief economist at SGH Macro Advisors. “You could decide to hike rates as early as March or, depending on incoming data, keep pushing up until autumn.”

With core inflation of over four percent and an unemployment rate of 4.2 percent, Duy also suspects that many people at the Fed see the necessary conditions for an interest rate hike already met. But Powell is committed to a data-driven approach, and Omicron is sure to influence the data that comes in. So far, its effect has been deflationary. In the past few weeks, the price of crude oil has fallen by more than ten dollars a barrel – which should translate into cheaper gasoline in the coming weeks. That could be an argument as to why the Fed is sitting on its hands a little longer, collecting more information, and waiting until its monetary policy meeting in January before taking action.

On the other hand, this Thursday the Department of Labor will publish the consumer price index for November, which could show a further rise in the inflation rate, which would increase the pressure on Powell to act. During his first term as Fed chairman, he faced Donald Trump as president and the outbreak of a deadly global pandemic. His second term could prove to be even more challenging.

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