The Pendulum Has Shifted: The Fed Has Become Extremely Risk Averse

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Extreme criticism of the Federal Reserve (Fed) over the last year and a half has put Fed officials on the defensive, which means that it went from a highly benign view of inflation (i.e., it is transitory, and we can wait) to a very risk averse stance, which is where we find it today.

This is what we got from the Fed’s statement after the Federal Open Market Committee (FOMC) meeting on Wednesday as well as from the press conference given by the Fed Chairman, Jerome Powell. The pendulum has shifted so much that it is purposefully disregarding the better news on inflation we have gotten over the last several months and seems to be willing to overdo its play in terms of monetary policy today. And markets have reacted accordingly after becoming more upbeat in the last couple of months with what they thought was good news and advances on the inflation front.

This section from the Fed’s statement gives a clear view of its current extreme risk aversion stance:

Eugenio J. Alemán, PhD,
Click here to enlarge

This year the Fed had one such event: Russia’s invasion of Ukraine and the ensuing war, which sent oil and food prices through the roof and pushed it into the current risk aversion stance. And since almost all petroleum forecasts we have seen lately call for prices of petroleum to go back to $100 or higher, it is clear that the Fed is trying to be ahead of the curve in case this forecast comes to fruition and pushes inflation higher once again.

For this reason, we are including our ‘inflation heatmap’ in this report so we can see the different inflation paths and the time we will need for the Fed to attain the 2.0% inflation target going forward. Remember that these are very simple scenarios that assume that inflation changes at a constant rate per month in order to observe what would happen to the year-over-year rate of inflation for both the consumer price index (CPI) and the personal consumption expenditures (PCE) price index, which is the favored inflation number targeted by the Fed.