No matter the maximum inflation. Powell is wisely considering the long term.

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Inflation in the United States has been high enough for long enough that the debate about the peak of price increases has returned to fashion. The question is as out of place today as it was a few months ago. In fact, signs that inflation will remain too high for comfort mean the US is likely set for a period of higher interest rates, even if price increases appear to be peaking.

Federal Reserve Chairman Jerome Powell made this clear on Wednesday, when he told the public at a European Central Bank policy forum in Sintra, Portugal, that the real concern is that the United States United States could face sustained inflation well above the Fed’s 2% target.

Such conditions set in when inflation enters the public psyche and perpetuates itself: demand for workers rises to compensate for rising prices, and firms must raise prices further to compensate for rising labor costs. work. This fear will likely keep the central bank aggressive even when headline inflation appears to be plateauing. As Powell said:

The clock is kind of ticking on how long you’ll stay in a low inflation regime where most inflation moves are actually idiosyncratic, as opposed to the whole macro economy. So the risk is that due to a multiplicity of shocks, you switch – you start to switch to a regime of higher inflation, and our job is literally to prevent that from happening. And we will prevent that from happening. We will not allow a transition from a low inflation environment to a high inflation environment.

Policymakers keep tabs on inflation assumptions through surveys and other tools, but consumer inflation expectations in particular are extremely difficult to monitor. And once they appear in the data, it may already be too late. In Powell’s words, “there is no way of knowing in real time”. So it’s fair to assume that he’s going to err on the side of doing too much to control inflation, even if it looks like the economy is slowing and inflation is coming down, provided it’s still well on the way to inflation. above the 2% target.

Even during the inflationary 1970s, prices did not rise. Instead, there were several waves, with the index temporarily bottoming out higher than expected. This situation may have escalated until former Fed Chairman Paul Volcker crushed inflation with a devastating campaign of higher interest rates that made people so angry that he received death threats.

None of this means that the inflation alarmists will necessarily be right. As Powell has repeatedly acknowledged, the current episode is unique in that it continues to have a strong supply-side element, and the prices of many things could pull back as fast as they have. climb. It seems that this is already happening in the commodity markets.

In the meantime, the Fed is taking a risk management approach to inflation. For traders looking at shorter-term bond yields, this would seem to suggest that there is a fairly clear floor on how low yields can go from here, unless it becomes clear that inflation was gutted.

Powell, a soft-spoken president who doesn’t get very animated, showed his fiery side on Wednesday during this exchange on inflation expectations: his wide gaze and gesticulations revealed he meant it when he spoke about prevent inflation expectations from taking root. A student of history, he intends not to be remembered as another Arthur Burns, who chaired the Fed for much of the 1970s and failed to bring inflation under control, leaving the task to Volcker.

Clearly, there are plenty of reasons to suspect that inflation will slow soon enough, which would likely mean fewer rate hikes, but probably not many. Powell says he doesn’t want his policies to cause a recession, but he clearly sees the risk of long-lasting inflation as the greater of two evils. “There is definitely a risk” that monetary policy will hurt the economy, Powell said on Wednesday. “But I wouldn’t agree that’s the biggest risk to the economy. I think the biggest mistake to make – let’s put it this way – would be not to restore price stability.

For investors, the biggest mistake would be to ignore this warning because it looks like they really mean it.

More writers at Bloomberg Opinion:

Home builders still find strong demand in cooling market: Conor Sen

Inflation ate your free lunch, but you’re still better off: Allison Schrager

US economy heading for hard landing: Bill Dudley

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.

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Carol N. Valencia