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 judges “substantial further progress” has been made towards its inflation and employment goals. The Federal Reserve’s (Fed) forward guidance on the economic conditions necessary to increase interest rates and reduce asset purchases within the Statement remained unchanged.

While the Committee continues to anticipate a prolonged period of accommodative monetary policy will be necessary to promote the recovery, they are beginning to hint at the eventual normalization of ultra-easy policy as the economy returns to pre-COVID levels and rising vaccinations reduce the public health risks. This is reflected in the Dot plot, which showed an increase in the 2023 median dot from 0 to 2 rate hikes in 2023.

There was also a technical adjustment to the overnight reverse repo and the interest on excess reserve rates, which were both increased by 5 basis points (bps) respectively, to 5 bps and 15 bps, in order to maintain the integrity of the Fed’s target range in an abundant reserve regime. 

Committee Statement

• Economic Assessment – The economic assessment maintained an optimistic tone by referencing further progress on vaccinations, which has reduced the spread of COVID-19. The statement maintained language reflecting that recent CPI strength was driven by mostly transitory factors.

• Outlook – The Fed continues to view the path of the economy as dependent on the course of the virus and that risks remain despite the progress on vaccinations.

• 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 USD (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.

Summary of Economic Projections

Investors received FOMC participants’ outlooks for growth, inflation, employment, and policy rates expectations through 2023. Growth expectations were upgraded to 7% in 2021 but mostly unchanged in 2022 and 2023.  On inflation, the median of the committee expects a near term overshoot of core PCE in 2021 to 3%, followed by a sharp retracement to 2.1% in 2022 and 2023. Unemployment forecasts were unchanged, with a forecasted decline to 4.5% by year end, 3.8% in 2022 and 3.5% in 2023.

The committee shifted its expectations materially for the path of the Fed Funds rate despite only limited changes to inflation and unemployment in the out years (2022 and 2023). The median committee member expects two rate hikes in 2023. In addition, 7 members anticipated rate hikes as early as 2022, compared to 4 members at the last meeting. The dispersion of forecasts in 2023 is notable with the two most hawkish members forecasting a Fed funds rate at 1.625% in 2023, while the 5 most dovish members still forecasting the Fed Funds rate at the zero lower bound through 2023. 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 the labor market, inflation, the eventual tapering, and the SEP:

• Labor market: The committee attributes the supply and demand mismatch to a variety of temporary factors. Looking beyond the next few months, the Chairman was optimistic on the prospects for a very strong labor market and the potential for job growth to pick up in the summer and fall.

• Inflation: On inflation, Chair Powell continued to reference transitory factors he felt were driving inflation higher including base effects, energy prices, and supply chain bottlenecks. However, he also noted that the unprecedented reopening post-pandemic may result in large and rapid shifts in demand, which coupled with supply constraints and hiring difficulties, may result in inflation being higher and more persistent than they expect.  

• Tapering: Chair Powell specifically referred to today’s meeting as the meeting in which they are “talking about talking about tapering.” He reiterated that they will only taper once substantial further progress has been made, something they will monitor each meeting, and that they will communicate carefully and well in advance of any change to their purchase program.

• SEP: The main message that Chair Powell wished the market to take away from the SEP is that many committee participants are now more comfortable that the economic conditions necessary to hike rates will be met sooner than previously anticipated.  

Our View:

• We expect the Fed to keep policy rates at the zero lower bound for the foreseeable future, as well as to continue their asset purchase program. For now, we expect the Fed to keep their word by remaining accommodative despite higher inflation as long as it continues to be associated with what they believe to be transitory factors. 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 is robust.

• 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 expectations have reduced the hurdle rate for the Fed to achieve substantial progress in the labor markets. 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.

• 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, a continued tailwind from fiscal policy, and the eventual tapering announcement.