We are in the middle of a transition in the policy of the Federal Reserve. For all the hawkish rhetoric the Federal Reserve is still putting out and the still too-high inflation reports, official policy is shifting. We know this because the unofficial mouthpiece for the internal thinking of the Federal Reserve is revising his tune.

Nick Timiraos, the Fed Whisperer, is changing his tune from October when he was still talking about interest rate hikes and increasing inflation. When Timiraos shows a shift, that signals a new policy direction for the Federal Reserve. Timiraos was told about the rapid increases and the growing divisions in the Federal Reserve Board of Governors. Now he's signaling a more dovish policy from the Fed.

In a weekend story for the Wall Street Journal, Timiraos writes, "Federal Reserve officials are preparing to slow interest-rate increases for the second straight meeting and debate how much higher to raise them after gaining more confidence inflation will ease further this year."

Slowing inflation?

Why are we seeing this shift now? Timiraos says the Fed sees slowing inflation this year. "The likely decision to approve a smaller increase in February reflects officials' growing confidence that the economy is responding to their efforts to curb demand and bring down inflation."

The critical part of Timiraos's reporting is how he frames the Fed's new mindset. He says the Federal Reserve is now pondering two questions:

At the coming meeting, officials could deliberate two important questions: How long does it take for the full effects of the Fed's rate rises to influence hiring and overall economic demand? And how much could inflation slow due to other factors such as easing supply-chain bottlenecks or lower costs of fuel and other commodities?

That first question relates to the "wage-price spiral" the Federal Reserve is most scared of with inflation. If employers continue pushing wages up to keep employees, those costs get passed on to consumers, causing an increase in prices. Currently, the Federal Reserve is trying to drive up unemployment to prevent a wage-price spiral.

We have yet to see much unemployment increase outside the technology and real estate industries. The Fed wants higher unemployment when employers are short on employees. It's a difficult needle to thread.

China reopening and an evolving global economy.

The second question relates to the direction of inflation year with supply chains, China reopening, and more. This question is important but outside the Fed's control.

China is a critical component of global inflation. There are early signs that China's reopening is having a similar impact to the reopening of the United States, Europe, and other parts of the world. There's an immediate spike in consumer demand, which can cause price inflation.

The Wall Street Journal adds on China, "China will likely consume more energy as its economy recovers, putting upward pressure on prices of oil and other commodities. At the same time, however, its reopening could ease supply-chain bottlenecks and enable factories to boost production, resolving some problems that contributed to higher inflation."

It's too early to tell which direction China's reopening will have, but there will be downstream impacts. Much like American consumers when we reopened, Chinese consumers are also flush with cash and willing to spend. Domestic consumption could cause inflationary stress elsewhere.

Lawrence Summers warns of more work.

Lawrence Summers, who warned the Biden White House and the Federal Reserve about the dangers of inflation, continues saying the Federal Reserve has more work to do. Summers has been right so far throughout the inflation debate. In an interview, he argued, "The economy could be slammed with a 1970s-style financial crisis if the Federal Reserve abandons its inflation target and lets prices run higher."

Summers is arguing for a very simple task: for the Federal Reserve to finish the job on inflation. He doesn't want the Federal Reserve to let up on its aggressive stance and allow prices to surge again. If inflation gains momentum, the Fed will have to push rates higher than they are now to tackle the problem.

Other issues could play into the economy too. The ever-present war in Ukraine could fire back up, increasing pressures on supply chains depending on those two countries. COVID-19 can flare up, causing economic slowdowns. And there are any number of headwinds that could cause financial problems. 

Fed Whisperer Speaks.

The Federal Reserve wants to slow down rate hikes and figure out if it solved the problem. It's too early to tell right now. Inflation is slowing, but most people find housing more unaffordable than ever. Rent, mortgage rates, car loans, and more make purchasing fundamental things challenging. Food prices also continue to go up, increasing basic costs for everyday Americans. 

The Federal Reserve has made considerable progress regarding inflation - but prices continue to increase. Telling people that costs are going up slower than before isn't much help. Most Americans want the opposite: deflation. Prices have climbed so much in the past two years that whatever wage gains most people have made are getting eaten away by higher costs of living.

But we know the Federal Reserve's policy is changing. The Fed Whisperer has spoken, and everyone should take note.