A fresh flock of doves
At its first policy meeting of 2021, in a widely anticipated move, the Federal Open Market Committee (FOMC) voted to maintain the current Federal funds target rate at a range of 0.00%–0.25% and to continue purchasing U.S. Treasuries and agency mortgage-backed securities by at least USD 80billion and USD 40billion (net) per month, respectively, until the committee feels “substantial further progress” has been made towards its inflation and employment goals.
Relative to the December meeting, there were minor changes to the statement that suggest the committee may be more concerned about the outlook. After highlighting improvements in economic conditions at its last meeting, today’s statement acknowledged the recent softening in the labor market and inflation metrics caused by a resurgence in the virus through the fourth quarter. Elsewhere, Federal Reserve (Fed) Chairman Jerome Powell’s comments during the press conference provided some, albeit vague, guidance on the committee’s asset purchase program. There, Powell commented that the committee would view a recovery-driven move higher in consumer inflation as only transient, dismissing the notion the committee might act prematurely by changing the composition of its asset purchases in response to higher inflation in the back half of the year. Moreover, he also mentioned there would be plenty of forward guidance before the committee would begin to taper its asset purchases. With this in mind, we anticipate the committee could begin discussing tapering at the September meeting, and actually begin reducing purchases in March 2022.
It should also be noted that today’s meeting featured five new voting members, four of whom rotated on as part of the annual rotation of federal bank presidents, with the fifth being a permanent appointment of Christopher Waller, a well-known “dove”. Our analysis of Fed speeches and past voting behaviors suggests the makeup of the new committee skews slightly more dovish than last year. Importantly, however, the committee has been signaling for some time that they intend to keep policy rates at zero and this new voting body is likely to stay the course, at the very least through 2021. Investors should also keep in mind that, for reasons completely separate from the pandemic, but in line with longer-term trends in inflation and growth, it adopted—and reaffirmed today—it’s new policy framework committed to a more patient approach in raising rates.
Moreover, with the recent appointment of Janet Yellen as Treasury Secretary, there are decisively dovish parties in both the Treasury Department and the FOMC. Altogether, a fresh flock of doves in Washington should keep policy rates anchored at zero, asset purchases staying steady for the balance of year and plenty of room for further fiscal support. While equity markets and bond yields traded lower, the key point for investors is the Fed has committed to an accommodative stance for some time, supported by the committees view of low inflation as a greater risk than higher inflation, suggesting a steeper yield curve over the medium term as further fiscal stimulus and vaccine distribution lead to a strong rebound in growth and inflation in 2H21.
- The FOMC’s steady level of support is an important ingredient in our risk-on posture across our multi-asset portfolios. While our baseline macro scenario assumes an eventual hand-off between easy monetary policy-driven financial conditions and the recovery underway in corporate earnings, we do not expect an imminent withdrawal of either Fed bond purchases or long-term rates guidance. Moreover, the balance of fiscal and monetary policy in the coming years looks to be much more even and pro-cyclical than in past recoveries, which bodes well for a faster snap-back in economic activity and skinnier left tail risks along the way. A weak inflation trend (beneath noisy year-on-year readings in the coming months) will reinforce both of these dynamics.
- Against this backdrop we continue to lean into equities and credit, with an emphasis on relatively cyclical regional exposures. Those regional bets are subject to volatility as markets contemplate fast-moving virus dynamics, the timing of vaccine rollouts, and the extent of overall fiscal policy thrust but, in our view, oscillations around a constructive macro trend are unlikely to be very persistent. In the background, and notwithstanding bouts of market volatility, trends towards a weaker dollar and lower market volatility also suggest spreading equity bets more broadly outside of the U.S.
- The Fed’s rates guidance and robust global demand for Treasuries are likely to keep a lid on bond yields, even as they are expected to rise alongside GDP growth over the course of the year. Success for monetary policy-driven reflation is likely to mirror the trends we saw at the end of 2020, with real yields remaining low and market inflation expectations rising. The net effect of this push and pull, and policymakers’ ostensible desire to err on the dovish side of things suggest limited scope for explosive increases in nominal yields, keeping us neutral duration.
Global Fixed Income, Currency & Commodities
- We expect the Fed to keep policy rates at the zero lower bound for the foreseeable future as well as continue their asset purchase program. With unemployment still elevated versus pre-COVID levels, additional fiscal and monetary action continue to be required, even as vaccine distribution has begun.
- If the outlook for economic activity deteriorates materially or inflation moves further away from the Fed’s target, we expect the Fed to extend the average maturity of its Treasury purchases or increase the pace of purchases to promote further easing.
- We expect the 10-year Treasury yield to trade in a range of 1% - 1.25% with risks to the upside as we move into the latter half of 2021.