Market Views from the Global Fixed Income, Currency & Commodities (GFICC) group

The Federal Open Market Committee (FOMC) voted to maintain the current Fed Funds rate at the zero lower bound (0.00%–0.25%). The Committee reaffirmed its commitment to USD 120 billion in asset purchases per month until “substantial further progress” has been made towards its inflation and employment goals. The Committee judged that progress has been made since the Committee first set this objective last December, but purchases are still appropriate.

Committee Statement

• Economic Assessment – The economic assessment maintained an optimistic tone on the recovery while recognizing that the sectors most adversely hurt by the pandemic have not fully recovered. The assessment on inflation was unchanged.  

• Outlook – The Fed continues to view the path of the economy as dependent on the course of the virus but removed the description that the economy was “significantly” dependent on it. Nevertheless, risks to the outlook remain.

• Current Policy and Forward Guidance –
  • The Committee maintained its prior guidance that policy rates will remain at zero until the labor market has achieved full employment and PCE has reached 2% and is expected to rise modestly above 2% for some period of time. Furthermore, the FOMC has committed to maintaining more broadly accommodative monetary policy until inflation averages 2% as long as longer-term inflation expectations are anchored. 
  • On asset purchases, the Fed also remained committed to the current pace of treasury and agency mortgage-backed securities (MBS) purchases in order to promote easy financial conditions and smooth market functioning.  The current pace stands at USD 80 billion (gross) per month in treasuries, and USD 40 billion  (net) per month in agency MBS. The Fed remains flexible to adjust the purchases but will keep the program at least at the current pace until it has judged that the economy has made “substantial further progress” toward the Fed’s price level and employment goals. The Fed does believe that progress has been made since the Fed first set this benchmark last December and will be assessing further progress in the coming meetings.

Chair’s Press Conference

At the press conference, Chair Powell made several important comments relating to the labor market, inflation and the eventual tapering:

• Labor market: The Chairman remained optimistic on the prospects for the labor market and the potential for job growth to pick-up further in the summer and fall.

• Inflation: On inflation, Chair Powell reiterated his belief that transitory factors were responsible for most of the uptick in inflation. That being said, he noted that the unprecedented nature of the reopening post-pandemic may result in inflation being higher and more persistent than they expect. Chair Powell described “transitory” as a price increase that does not leave a “permanent mark on the inflation process”.

• Tapering: Chair Powell said the Committee discussed different options for tapering asset purchases (timing, pace and composition) but agreed that “substantial further progress” had not yet been made.
  • On the labor market side, Chair Powell viewed us as being “some way away” from achieving its goals and that they needed to see additional strength in payrolls. On inflation, he recognized that inflation is and will be running above 2% for a period of time but declined to comment on how the recent developments in inflation linked back to their objectives.
  • Chair Powell viewed Agency MBS and Treasury purchases as broadly affecting financial conditions in very similar ways and therefore he expected that both would be tapered at the same time. He said the Committee was still discussing the relative pace of Agency MBS and Treasury purchases. In terms of the start date of taper, he reiterated that they will communicate well in advance of any change to their purchase program.

Our View:

• We believe the Fed will begin to taper asset purchases in early 2022 and start hiking rates in H2 2023. The inflation developments over the past quarter across realized indices (CPI, PCE) as well as market and survey based inflation expectation measures have reduced the hurdle rate for the Fed to achieve substantial progress. The traditional disinflationary cycle that occurs after a recession has been short-circuited by the fiscal and monetary policy response. Supported by supply chain bottlenecks, inflation and wages have returned to and are set to maintain their pre-COVID underlying trends.

• Overall, we expect the Fed to keep policy highly accommodative for the foreseeable future. With unemployment elevated and labor force participation depressed versus pre-COVID levels, an accommodative policy stance is still warranted, even as vaccine distribution has been strong and growth remains robust. We anticipate that the Fed will continue to keep their word by maintaining an easy policy stance despite higher inflation as long as it continues to be associated with transitory factors and inflation expectations remains anchored.

• We expect the 10-year U.S. Treasury yield to move higher this fall with a year-end target of 1.875% - 2.125%. U.S. Treasury yields should be biased higher as a result of continued above-trend growth, additional fiscal stimulus and the eventual tapering announcement.