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Yellen is quite concerned about hotter inflation and housing market; Fed/Powell may signal an imminent MBS QE tapering

calendar 19/07/2021 - 10:13 UTC

The U.S. Treasury Secretary Yellen is now also concerned about hotter inflation and the housing market. On late Thursday, Yellen said in an interview that she sees ‘several more months of rapid inflation’ before easing and she is quite worried about higher prices of homes as it may affect the affordable housing segment going forward.

On Thursday, Yellen was asked about the prospect of U.S. economic recovery. Yellen said she expects almost full employment recovery by 2022:

“Well, you know--- my--- I have expected that next year the economy would get back to full employment or something very close to it. And that remains my expectation. So, we are seeing people go back to work. I expect that to continue. There’s plenty of ability to spend that remains in the pipeline to drive continued growth. And, you know, they're still really a lotta people who need to be put back to work. So I expect a recovery certainly to continue at a good, good, strong pace into next year”.

On +5.4% CPI (inflation) reading in June and whether it’s concerning, Yellen said the Biden admin is committed to bringing inflation under control over the medium term and is watching the present situation very carefully. But Yellen personally sees the transitory nature of the inflation associated with consumer-facing service sectors that were now reopening like travel & tourism. Yellen also pointed out except for motor vehicles, the headline CPI should be around +2.10%, consistent with Fed’s longer-term objectives of +2.0%. And prices of motor vehicles are soaring due to supply chain disruptions and bottlenecks:

“Well, look, we, we certainly wanna make sure that inflation stays under control over the medium term. And we need to be very attentive to what’s happening with inflation, developments. We are watching them closely. My read of what’s happening is that inflation is largely confined to sectors that were, that are now opening back up. We’re seeing big increases in airfare--- airfares, hotels and there are bottlenecks and supply chain problems that have particularly affected motor vehicles. So if you look, for example, at last month’s inflation report, if you strip out motor vehicles and those sectors that were most affected by the pandemic and are now rapidly opening up, inflation was running at about two, 2/10s of a percent, which is consistent longer run with, with 2% inflation”.

Yellen was promptly (rudely) asked when she thinks such hot inflation will ultimately settle off. A visibly upset Yellen said she thinks the U.S. will have ‘several more months of rapid inflation’—not a few, but she also believes that being transitory, presently elevated inflation will decline over medium-term towards normal levels. In any way, Biden admin is watching inflation scenario very carefully and future inflation expectations are well anchored with Fed’s assessment of +2.0%, which is more important for price settings behavior:

Well, I think, we will have several more months of rapid inflation so I’m not saying that this is a one-month phenomenon. But I think over the medium term, we’ll see inflation decline back toward normal levels. But, of course, we have to keep a careful eye on it. You know, measures of inflation expectations I think still look quite well contained over the medium term. Those expectations are a driver of price-setting behavior. And so we must monitor it carefully. But I believe fundamentally, you know, that this is something transitory that will settle down.

Yellen was asked why Biden admin is planning to inject trillions of more dollars into the economy through traditional and human infrastructure stimulus, which may fuel more inflation irrespective of the transitory or sticky (persistent) nature. Yellen defended that the proposed stimulus package is planned over 10-years with a decent level of annual spending and a long term plan to address long term U.S. problem to make the economy more productive; not a short term solution, which can make the economy hotter:

Well, we, the American Rescue Plan have injected a great deal of spending, the wherewithal for spending, into the economy to promote recovery. And I think we’re seeing it having the desired effect as well as preventing scarring and harm to families and their finances., the new programs that we hope to see enacted are spent out money over ten years. It’s a much more modest, annual level of spending. It’s not on the same scale as the stimulus and rescue, the Rescue Plan. And it’s, it’s intended to address long-term problems in the U.S. economy that we’ve ignored for too long.

A deficit in public spending on infrastructure which is important for firms to be able to be productive will affect advancing productivity growth. We’re trying to address climate change, which is a very serious threat that we all recognize we must address. We’re investing in our workforce, early childhood education and community college---Investments in childcare so that people can participate in the workforce, paid leave. All of these things are long-term problems that we’ve had. And they’ll boost labor force participation and boost productivity. And there, they’re the investments. R&D is also part of-- These packages. It’s not a short-term shock. It’s these are long-term investments to make our economy more productive.

On housing and whether there is overheating, Yellen said she is not concerned about the 2008 GFC-like housing bubble because mortgage credit is now being provided only to quality (creditworthy) borrowers and not to sub-prime borrowers. But she is quite concerned about the affordable housing segment and thus Biden admin is pushing for more supplies of low-cost housing in its forthcoming stimulus plan:

Well, we have seen a big increase in housing prices in part due to the changes from the pandemic and the low-interest-rate environment we have. I, you know, the lending that’s taking place is to credit-worthy borrowers. So, I don’t think we’re seeing the same kinds of danger in this that we saw in the run-up to the financial crisis in 2008. It’s a very different phenomenon. But I do worry about affordability and the pressures that higher housing prices will create for families that are first-time homebuyers or have less income. And a portion of the plans will be under consideration by Congress-- they Will be intended to boost affordable housing, the supply of affordable housing.

Yellen was asked why U.S. bond yields are now on the downside despite hotter inflation and expanding economy. Yellen explained that it’s a reflection of market confidence inflation will remain under control (at moderate levels) in the medium to long term after pandemic led transition factors:

Well, to my mind, that’s, the market expressing its views that inflation does remain under control. And that some of the longer-term forces that were operative in our economy before the pandemic that we associated with secular stagnation, namely a large supply of savings and relatively weak investment demand, but although we’re in a complex transition period because of the pandemic, long term market participants haven’t forgotten about that and I think do see a world in which interest rates will remain at moderate levels and inflation will remain well under control.

On increasing infection by Delta variant of COVID in the U.S. and how it threatens the U.S. economic recovery and whether there would be a fresh lockdown, Yellen acknowledged the same as a risk for not only the U.S. but around the world. Yellen also pointed out the U.S., along with Europe is trying to accelerate COVID vaccinations in low-income (developing) countries so that emerging COVID variants get controlled there and do not pose a transmittable threat for the developed countries. Having said that, Yellen also pointed out Delta COVID spikes in certain unvaccinated areas of the U.S. can also cause partial lockdown in those regions:

Well, I do think it’s a risk. I think it’s not just a question of the United States. It’s a question of risks around the world. I am very concerned that, although advanced countries are making good progress with vaccination in many parts of the world and especially in low-income countries, vaccination rates are extremely low as long as that’s true and this virus is easily transmittable across borders, we have to worry about the development of variants that could pose future threats.

One of the things we discussed at the G20 in Venice is the need to accelerate global programs in vaccination and we talked about some of the logistical problems that are preventing that. And the IMF, the WHO, the World Bank, the World Trade Organization have formed a task force to try to be more agile in sending vaccines to parts of the world where we see threats. But within the United States, we do have areas where vaccination is lower and I think we do have to worry about outbreaks in parts of the country.

So, I mean, we have solid rates of vaccination in many parts of the country. But certainly it (lockdown), it’s something that could, could happen in areas where vaccination rates are low so it is critically important that we maintain progress on vaccinating more Americans.

On the prospect of Powell’s 2nd term as Fed Chair early next year and the similarity of view on elevated inflation as transitory, Yellen virtually signaled Powell will be continued:

That’s a discussion I’m gonna have with the President---Well, look, I, you know, I’ve given you my personal views on inflation. I have a lot of respect for the Federal Reserve. And they need to make independent judgments about what’s, what’s appropriate. I think you know, the Fed has done, has done a good job.

Finally, on China’s recent crackdown on tech companies including the Didi IPO fiasco and whether these harsh Chinese actions are an effort to hurt U.S. investors, Yellen said both countries are quite concerned about hi-tech and data privacy, but she is in touch with his Chinese counterparts and discussing a wide range of issues:

I think we have issues around data privacy and technology. And both sides are looking carefully at this, this set of issues. I, I have been in touch with my Chinese counterparts. And we have discussed a range of issues. And I expect that that will continue.

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Bottom line:

Yellen is quite concerned about hotter inflation and the housing market, which is going to be an election/political issue in the 2022 mid-term election. Real wages of U.S. workers are now falling as Bidenflation is soaring more than wages, while the cost of living is increasing rapidly, something which many Americans didn’t see in there in the last few decades. Bidenflation has replaced unemployment as a top concern for consumers.

In economics, there are usually two phases under such run-a-way inflation. In phase one, the public pulls back from purchases at the high prices, hoping prices will come down in the coming days-trying to save as a precautionary hedge. We may be in this phase one scenario currently. In phase two, consumers panic and decide to go on a buying spree in an attempt to beat the rising price, which creates even more inflation. Thus Fed is now focusing more on inflation expectations in the future rather than real inflation right now, although this is contrary to Fed’s narrative that it will look into actual data, not an assumption in its policy-setting issues.

Fed Chair Powell is already under pressure from U.S. Congress, especially opposition Republicans and some ruling Democrats (moderates) for allowing the U.S. economy to run hot instead of at goldilocks pace. The mandate of the Fed is maximum employment, ensuring price stability at +2.0%. The price stability mandate is Fed’s primary objective (priority). The Fed will aim for maximum employment; i.e. maximum economic growth by ensuring 2% price stability.

The Fed is not supposed to allow running the U.S. economy at a substantially higher inflation rate than 2% for long. In the testimony this week, Powell himself admitted quite a few times that U.S. inflation is now running ‘substantially’ higher than the target of +2% and it can’t be termed as ‘moderate’. The U.S. core PCE inflation is now running around +0.35% sequentially (m/m) on average, almost thrice from +0.13% in 2019 (pre-COVID). At the current run rate and underlying trend, the U.S. core PCE inflation may be well above +4.00% to even +6.00% in 2021, ‘substantially’ above Fed’s estimates of +3.0%. Thus Fed is bound to take some tightening actions in the July meeting and may signal MBS QE tapering by Dec’21 or Mar’22.

 

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