FOMC: September 2021
U.S. Rates Team
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 is moving closer to tapering its asset purchases of USD 120 billion per month. They signaled that progress had been made to their goals and that if the progress continues as broadly expected, a moderation in asset purchases will soon be appropriate. On an operational note, given the strong demand for the overnight reverse repo facility, the Fed doubled the per-counter-party limit to USD 160 billion per day.
- Economic Assessment – The economic assessment was little changed. The Committee maintained an optimistic tone on the recovery while recognizing that the increase in COVID-19 cases has slowed the recovery. The FOMC continues to view inflation as elevated due to transitory factors.
- Outlook – The Fed continues to view the path of the economy as dependent on the course of the virus and recognizes that risks to the outlook remain.
- Current Policy and Forward Guidance –
- The Fed remained committed to the current pace of asset purchases but indicated that its goals of “substantial further progress” had nearly been met and that tapering should be expected at the coming meetings if the recovery continued to move forward as expected. The current pace stands at USD 80 billion (gross) per month in treasuries, and USD 40 billion USD (net) per month in agency MBS.
- On the timing of rate hikes, 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.
Summary of Economic Projections
Investors received FOMC participants’ outlooks for growth, inflation, employment, and policy rates expectations through 2024. Growth expectations were downgraded in 2021 but upgraded in 2022 and 2023. On inflation, expectations were revised up, and the median of the committee expects inflation above 2% throughout the forecast horizon with forecasts for core PCE of 3.7% in 2021, 2.3% in 2022, 2.2% in 2023 and 2.1% in 2024. All 18 participants view their level of uncertainty around PCE inflation forecasts as higher compared to the prior meeting, and 13 view the risks to their forecasts as being weighted to the upside – same as last meeting but at the highest level on record. The unemployment forecast was revised up 0.3% to 4.8% in 2021, but left unchanged at 3.8% in 2022 and 3.5% in 2023.
The addition of the 2024 dot gave us new insight into the pace of rate hikes the Committee anticipates to be appropriate after lift-off. The median of the Committee now expects 6.5 rate hikes through 2024 starting in 2022. The Committee was evenly split on a rate hike in 2022, and expects three rate hikes in 2023 and 2024. That said, there was healthy divergence among the committee in their 2024 dots totaling 200 bps. The Fed’s long-run neutral rate of 2.5% was not changed.
Chair’s Press Conference
At the press conference, Chair Powell made several important comments relating to inflation, the labor market, tapering, and rate hikes:
- Inflation: Chair Powell reiterated his belief that transitory factors were responsible for most of the uptick in inflation. He also stated that the “substantial further progress” threshold from an inflation perspective has been achieved. Lastly, he viewed the 2.2% and 2.1% core PCE forecasts in the out years as “modest overshoots”.
- Labor market: The Chairman remained optimistic on the prospects for the labor market and the potential for job growth. While the committee was not unanimous in its assessment that the labor market had achieved “substantial further progress, Chair Powell, himself, viewed the test as “all but met.”
- Tapering: While the committee is not yet unanimous, Chair Powell stated that if the economy progresses broadly in line with expectations, it will be time to taper, and they could “easily move ahead at the next meeting.” He also expected that so long as the recovery remains on track, tapering that concludes around the middle of next year would be appropriate.
- Dot Plot and Rate Hikes: Despite the Dot Plot showing the committee evenly split for a rate hike by year end 2022, Chair Powell emphasized that the economy is still “well away from satisfying the liftoff test.” He reiterated that the criteria for tapering and tightening policy were distinct and that the economic conditions toward the end 2022, with an emphasis on the labor market, will determine whether a rate hike is warranted.
- The labor market has recovered more than 75% of the jobs lost during the depths of the pandemic. The traditional disinflationary cycle that occurs after a recession has been short-circuited by the fiscal and monetary policy response. Inflation and wages are showing signs of more persistence even after transitory factors fade.
- We believe the Fed will begin to taper asset purchases soon after a formal announcement at the November meeting. With tapering complete by summer, we view rate hikes as most likely to start by mid-2023 after the Fed pauses to assess the landscape.
- Overall, we expect the Fed to keep policy highly accommodative due to elevated unemployment and still depressed labor force participation.
- We expect the 10-year U.S. Treasury yield to move higher with a 6 month forward target of 1.5% - 2.0%. U.S. Treasury yields should be biased higher as a result of continued above-trend growth and the beginning of the removal of policy accommodation.