Quickly improving economy, with a slow moving Fed
Dr. David Kelly
Recent economic and employment indicators have improved markedly in recent weeks. The Federal Open Market Committee (FOMC) appropriately acknowledged this recent strength, while continuing to reassure investors it would not act prematurely in pulling back monetary support. The committee voted to maintain the current Federal funds target rate at a range of 0.00%–0.25% and reaffirmed its commitment to 120bn USD in asset purchases per month, until the committee feels “substantial further progress” has been made towards its inflation and employment goals.
Relative to the March meeting, there were material changes to the statement language. Notably, the committee highlighted the progress on vaccinations and fiscal stimulus as the primary drivers of the recovery and even noted the improvement in sectors hardest hit by the pandemic. Further, the committee replaced its language around inflation running persistently below 2%, with “Inflation has risen, largely reflecting transitory factors,” reflecting the committee’s view that higher inflation over the next few months will be short-lived and that it is more focused on anchoring longer-term inflation expectations at 2%. With that said, the committee continues to highlight the uncertainty around the outlook caused by the pandemic.
Elsewhere, during the press conference, when asked about when the committee would begin to think about tapering its bond purchases, U.S. Federal Reserve (Fed) Chairman Jerome Powell firmly stated “not yet.” However, while Chairman Powell continues to suggest that substantial further progress would need to be made before tapering would be considered, it’s reasonable to expect the criteria for “substantial” progress could be met by the end of the second quarter. Two back-to-back quarters of strong GDP growth and consecutive months of strong employment gains, could be enough for the committee to at least begin thinking about tapering and communicate that at its July meeting. An official announcement of plans to taper, however, may be delayed until its September meeting, after a few more months of strong data are realized. We still expect actual tapering to begin sometime in the first quarter of 2022. Regarding interest rate policy, transitory higher inflation through the first half of this year driven by base effects and supply chain bottlenecks likely won’t push the Fed to make any adjustments, at least until late 2022.
Equity markets were mostly higher immediately following the announcement, but reversed course somewhat, while bond yields were relatively unchanged. It should be emphasized that despite more upbeat readings on unemployment and economic growth this year, the overall position for Fed policy remain very dovish. With this backdrop, investors should be positioned for higher yields as strong growth and higher inflation are realized in the quarters ahead.