This column usually spotlights a key economic report or influential event coming in the week ahead that could influence investment markets. As the third calendar year of the COVID-19 pandemic approaches, let’s look beyond the sun setting on this week and 2021.
The credibility of the lender of last resort will be put to the test in the year ahead.
There is no argument the Federal Reserve saved the American economy from a deep and devastating depression. It rewrote its playbook in real time during the spring of 2020 as restrictions were put in place and consumers simply stopped out of fear of COVID-19. The mere act of action staunched the economic terror gripping the markets and gave confidence to investors.
The agency already has had to change its tactics in response to its misread of the stability of prices – one of its two mandates. For months, the Fed saw high inflation as transitory. Once it became clear inflationary pressures brought on by the pandemic were not easing, the bank accelerated ending its bond-buying strategy. After winding down that program in March, the bank’s next action option will be to raise its target short-term interest rate.
In 2022 its commitment to fight inflation with higher borrowing costs will be tested. Market odds are 50-50 the Fed will hike its rate as early as March, according to the CME FedWatch Tool which calculates probabilities based upon the interest rate futures market. While those market odds can change quickly, the bank is dedicated to maintaining its reputation and reliability for steady and deliberative action.
In the weeks ahead, that dedication will be pressured by COVID-19’s omicron variant. There is no appetite for 2020-like economic shutdowns, and perhaps there is no need. After all, vaccines have proved very effective at reducing the severity of the disease. Still, this latest mutation will muffle some economic activity, threatening to slow the second of the Fed’s mandates – full employment.
The tricky balance for the bank in 2022 is further complicated by politics. The year ahead is a mid-term election year with the balance of power on Capitol Hill at stake. Rising borrowing costs for consumers, businesses and home buyers is not politically palatable for those seeking re-election. Yet they may be necessary to help blunt the macroeconomic impacts of pandemic stimulus by the Fed and spending by Congress.
In the year ahead, the central bank’s reputation for independence and integrity will be pressured by economic crosswinds and politics.
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