The Federal Reserve might have to raise short-term rates sooner than expected, and that could prompt the central bank to end the tapering of its bond purchases early in 2022, according to S&P Global Ratings Chief U.S. Economist Beth Ann Bovino.
Most economists expect the Fed to begin raising short-term rates in the second half of 2022, a few months after wrapping up the taper of its bond-buying program. Fed Chairman Jerome Powell said last week that the central bank's bond purchases could end a few months sooner due to strong economic growth and high inflation.
The Fed had previously maintained that inflation was "transitory," in part due to supply chain pressures brought by the pandemic. Bovino said in the latest Street Talk podcast that after seeing inflation holding along a little too long, the Fed "blinked."
"I think that they finally realize that transitory doesn't cut it anymore," Bovino said. "I wouldn't necessarily say that means we're going into a period of persistent inflation."
The economist said the Fed is working to get ahead of the issue and accordingly now expects the Fed to taper bond purchases much faster than they had previously indicated, which was expected to conclude in June 2022. Bovino expects the tapering to end by March 2022. Bovino believes that the Fed will first raise the fed funds target rate in September 2022 but noted that a quicker end to tapering would allow the central bank to raise rates even earlier.
Some market watchers have grown increasingly fearful of rising inflation as prices on many products continue to rise while wage gains have reached a 14-year high. Bovino said many people have questioned whether the U.S. could again experience a wage spiral like the one that occurred in 1970s, when inflation reached historic levels. Bovino does not expect that to occur and pointed to a number of structural differences in the economy today.
For instance, the economist noted that there were oil and food shortages in the 1970s, whereas shortages today are tied to temporary supply chain disruptions. Bovino also noted that many women joined the workforce in the 1970s, while many have left during the pandemic.
"That doesn't mean the Fed doesn't want to get behind the curve," Bovino said. "My indication is that they seem to have blinked and are moving on it now."
The unemployment rate stands at 4.2%, but when adjusting for people who have left the workforce, the unemployment rate would be 6.5%, the economist said. About 30% of the people who have left the labor market are unemployed, but more than 70% have left the market entirely, Bovino said.
Bovino suggested that fears over COVID-19 and the inability to obtain childcare have played a bigger role in keeping people out of the workforce than expanded unemployment benefits discouraging people from returning to work. Bovino acknowledged that those expanded benefits added close to $15 an hour to workers' benefits but noted that states that ended the additional payouts in June also reopened their economies early. And those states have reported unemployment rates that were 3x lower than the states that extended the expanded benefits through September, Bovino said.
Among the 70% of people who left the workforce entirely, Bovino said 40% of those likely retired early. The economist said the remaining cohort is likely tied to temporary factors, including fears of contracting the virus. Bovino said about 45% of the people who have left the workforce were between 25 and 54 years old, and among that group, nearly 70% were women, who continue to shoulder the bulk of childcare duties in the U.S.
"We suspect that they were worried about the fear of the virus, particularly for their children, who weren't yet able to get vaccinated. So the big question is, when will they be able to come back? I think the pandemic, the path of the pandemic, will decide that factor," Bovino said.
Bovino said that when the Fed becomes less accommodative, they could "take away the punch bowl," and that could cause businesses and the economy to slow. However, the economist noted that the economic expansion remains quite strong. Bovino pegged the current risk of recession at 10% to 15%, the lowest in almost seven years.
Bovino included a downside scenario in her latest economic outlook, which assumes the Fed has to move tighten more quickly to temper inflation. But even if that occurred, "we see a much slower expansion, but not necessarily one that causes recession over the next 12 months."
"Street Talk" is a podcast hosted by S&P Global Market Intelligence.
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