On Wednesday (4) of last week, the monetary policy committee of the Federal Reserve (or Fed), the American central bank, announced an increase in the interest rate – the fed funds rate (FF), their Selic – from the range from 0.25% to 0.5% for the range of 0.75% to 1%.
In the press conference following the announcement, the first in person since the beginning of the epidemic, Fed Chair Jerome Powell made it clear that the pace of increase of 0.5 percentage point is likely to continue at least for the next two meetings.
The financial market already expects the FF to rise to 3.3% in the middle of next year, and, it seems to me, it will have to rise a little more, up to approximately 4%, to bring inflation into the target.
As I have been dealing with in this space since the second half of 2020, the world economy has suffered consecutive shocks since the last quarter of 2019. We have to go back to the 1970s to find a period with a comparable sequence of shocks.
It is worth remembering the recent sequence. The first shock was the rise in meat prices, at the end of 2019, due to the African flu, which reduced the Chinese swine herd by 40%. In 2020, the herd was reconstituted in modern pig farms fed with feed. From one year to the next, the demand for soy and corn rose about 5%. The increase in grain prices makes the entire animal protein production chain more expensive: meat, dairy products and eggs.
In the same year of 2020, the “V” recovery of the world economy generated a strong increase in demand for industrial goods. The production of consumer durables uses intensively: chips, energy, metallic raw materials and international trade. An intense disorganization of the productive chains and an inflation of industrialized goods appeared.
This year, the expectation was for a reversal of the shocks. Before that came the Ukrainian War, which added more fuel to inflation. Ukraine is a major grain producer, and Russia is a major fertilizer producer.
In other words, the world is experiencing a new supply shock. The inflationary process runs its course. The IPCA in the US, called CPI, runs at 8.5% per year. The Fed uses the consumption deflator (the average inflation of consumer goods in the country) as a price index. It closed at 6.6%, for an inflation target of 2%. If we exclude items that suffered shocks, energy and food, from the consumption deflator, it runs at 5.2%, and the prices of services rise to 4.5%. All data are valid for the month of March.
In other words, the American inflationary process already shows some persistence. Meanwhile, the labor market is recovering and operating close to full employment or even already full employment: today, for every unemployed worker, there are almost two job vacancies looking for a worker.
The board of the Fed’s monetary policy committee still considers a soft landing scenario possible. In which the interest deflated by the expectation of inflation never stay above the neutral interest that is in force there, something around 0.5% real per year.
The soft landing scenario assumes that the Fed raises rates to around 2.5% and that the reversal of shocks brings inflation “by gravity” to the 2% target.
The inertia we have already observed in US inflation suggests that the soft landing scenario has become fiction. It will take time for Fed officials to recognize it, but it will take some monetary contraction to bring inflation to 2%.
We can only hope that the process does not require much more interest than the market sees. The perception that the American monetary policy will be more contractionary explains the devaluation of currencies against the dollar in the last three weeks.
Here, in addition to all the shocks that I mentioned in the column, we had the electric energy shock in 2021. The Central Bank raised the Selic, last week, to 12.75% and will make one more adjustment. It appears that your objective then will be to stop the cycle of rising interest rates. I don’t know if you can.
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