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%) and reaffirmed its commitment to USD 120 billion in asset purchases per month, until the committee feels “substantial further progress” has been made towards its inflation and employment goals. The Fed’s forward guidance on interest rates and asset purchases within the Statement remained unchanged.

The Summary of Economic Projections (SEP) provided further insight into the Fed’s reaction function. The median of the Committee expects above trend growth over the coming two years, accompanied by a modest rise in core PCE inflation, which reaches 2.1% at the end of the forecast horizon (2023), 0.1% above the Fed’s 2% target. At the same time, the median of the committee is not projecting any rate hikes over the next 3 years.

Overall, the Committee continues to anticipate a substantial and sustained period of accommodative monetary policy to promote the recovery.

Committee Statement

• Economic Assessment – The updated assessment reflects the recovery in activity so far in 2021. This brighter outlook is supported by rising vaccinations and additional fiscal support, which totals USD 2.8 trillion since the committee last met.
• Outlook – The Fed continues to view the path of the economy as highly dependent on the course of the virus and the pace of vaccination rollout; they still view the risks to the economic outlook as considerable.
• 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 at 2%. 
  • 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 USD (net) per month in agency MBS. The Fed did make a change by announcing the end of regular operations to purchase agency CMBS, which had only made up a small portion of total purchases. 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.

Chair’s Press Conference

At the press conference, Chair Powell reiterated most of his recent commentary and stressed that the U.S. economy is still a long way from its employment and inflation goals and that near-term positive developments should not result in complacency. It is likely to take “sometime” for “substantial further progress” to be achieved. He made several references to the transitory increase in inflation that the Committee expected this year, reassuring investors that this type of increase would not be sufficient to meet the Fed’s inflation objectives.

During the Q&A session, Chair Powell was asked to address the future of quantitative ease (QE). He continued to communicate that it was still too early to talk about tapering asset purchases and that they would communicate well in advance if the Committee felt substantial progress was being made. He emphasized that he wanted to see actual data, rather than making changes based on forecasts.

Finally, he was asked to discuss the Supplementary Leverage Ratio (SLR) and the challenges it could pose to monetary policy as bank reserves quickly grow. Chair Powell declined to comment stating that they will have something to announce in the coming days.

Summary of Economic Projections

Investors received FOMC participants’ outlooks for growth, inflation, employment, and policy rates expectations through 2023. 2021 growth expectations were significantly upgraded on the back of the USD 900 billion stimulus at the end of 2020 and the USD 1.9 trillion stimulus passed this month. This brought median real GDP expectations to 6.5% for 2021. 2022 was revised modestly higher from 3.2% to 3.3%, while 2023 was revised down 0.2% to 2.2%.

On the topic of inflation, the median of the committee expects a near term overshoot of core PCE in 2021 to 2.2%, followed by a retracement to 2% in 2022, and then settling in with a small overshoot in 2023 of 2.1%. Despite forecasting 2% or higher on core PCE in each of the next three years, the median committee member forecasted no rate hikes within this horizon. This is a strong signal that reinforces the Fed’s tolerance to allow inflation to overshoot 2% and highlights their reaction function under a flexible average inflation targeting regime. That being said, the number of committee members who expect a rate hike in 2023 increased from five to seven. Four participants forecast a rate hike in 2022. The Fed’s long-run neutral rate of 2.5% was not changed.

Our View:

• 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. For now, we expect the Fed to keep their word by looking through any transitory increases in inflation associated with the economy re-opening and base effects. With unemployment elevated and labor force participation depressed versus pre-COVID levels, an accommodative policy stance is still warranted, even as vaccine distribution has begun.
• We expect the 10-year U.S. Treasury yield to continue to grind higher as the year progresses with a year-end target of 1.875% - 2.125%. This continued rise in U.S. Treasury yields will likely be supported by strong growth and stimulative fiscal policy, which may eventually allow the Fed to signal tapering of asset purchases beginning in 2022 and rate hikes as early as Q4 2023.