Following the Federal Reserve’s (Fed) announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):
The Federal Open Market Committee (FOMC) voted to maintain the Fed Funds target rate at the zero lower bound (0.00%-0.25%). The tone of the statement continued to reflect the elevated level of uncertainty regarding the future path of the economy, despite further recovery in the labor market.
The majority of the changes within the statement reflected necessary adjustments given last month’s release of the Fed’s revised Long Run Goals and Policy Strategy. As outlined in the new long run policy statement, the Fed stated that after persistently undershooting its inflation target during the previous cycle, it now seeks to achieve a modest overshoot of its 2% target so that inflation averages 2% over time, which will keep longer-term inflation expectations anchored at 2%. The Committee stated that it expects policy to remain accommodative until both of these goals (average PCE inflation of 2% and anchored long-term inflation expectations) are met, in addition to achieving a level of full employment. Additionally, the Committee stated that it expects policy rates to remain at zero until the labor market has achieved the Committee’s assessment of maximum employment and PCE inflation is at 2% and is on track to moderately exceed 2% for a time. Finally, the Fed will continue with asset purchases at least at the current pace in order to support the flow of credit to households and businesses.
There were two dissenters at this meeting, Minneapolis Fed President Kashkari and Dallas Fed President Kaplan.
We can break the statement into three parts:
- Economic Assessment – The updated assessment highlighted the continued recovery in the economy, while maintaining a reference to the low level of activity compared to the beginning of the year. The assessment also continued to note easy financial conditions.
- Outlook – The Fed views the path of the economy as highly dependent on the course of the virus and the risks to the outlook in the medium term.
- Policy – The FOMC has committed to maintaining accommodative monetary policy until inflation averages 2% and longer-term inflation expectations are anchored at 2%. The Committee stated 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 a time. The Fed is also committed to maintaining the current purchase levels of U.S. Treasury, Agency Mortgage-Backed Securities (MBS) and Agency Commercial Mortgage-Backed Securities (CMBS). The current pace stands at USD 80 billion (gross) per month in U.S. Treasuries, USD 40 billion (net) purchases per month in Agency MBS and USD 1-2 billion per month in Agency CMBS. In describing the purpose of the Quantitative Ease (QE) program, the goal of sustaining smooth market functioning was accompanied with an additional rationale of promoting accommodative financial conditions.
Summary of Economic Projections
Investors received participant’s outlooks for growth, inflation, employment and policy rates expectations through 2023. While 2020 growth and inflation were revised higher and the unemployment rate was revised lower, the median of the committee remains committed to keeping rates at the zero lower bound through the forecast horizon. The Fed’s new flexible average inflation targeting approach was codified with a forecast of 2% PCE in 2023 but with no forecasted rate hikes by the median of the committee. The Fed’s long-run neutral rate of 2.5% was not changed.
Chair’s Press Conference
At the press conference, Chair Powell spent time discussing the implications of the recent update to the Fed’s Long Run Goals and Policy Strategy document. Specifically, the Fed’s forward guidance on interest rates which was updated to reflect the Fed’s flexible average inflation targeting policy. In addition, he recognized that the economy has recovered more quickly than previously expected, stated that levels remain well below pre-pandemic levels, and it would take a significant time to return to levels seen prior to COVID 2019. He noted that additional fiscal stimulus would be needed to address the many millions of people still unemployed and further promote the recovery.
Chair Powell was asked about the QE program which is aimed at fostering accommodative financial conditions and supporting market conditions. He communicated that the current pace of purchases is appropriate and that they would be willing to adjust the purchases going forward but was not willing to provide scenarios where he would consider increasing or decreasing the pace of purchases.
There were also questions on financial stability and what role it plays in monetary policy. He communicated that monetary policy should not be the first line of defense to address financial stability but rather should be addressed using regulation and macroprudential tools. At the same time, he noted that the Fed will not ignore any risks that impede the FOMC from achieving its goals.
- We expect the Fed to keep policy rates at the zero lower bound and asset purchases in place for the foreseeable future. With unemployment still significantly elevated versus pre-COVID levels and future fiscal policy uncertain, more action will be needed from both fiscal and monetary policy makers.
- In the absence of additional fiscal policy stimulus before the U.S. Presidential elections, we expect the Fed to introduce additional forward guidance or consider extending the average maturity of its U.S. Treasury purchases to promote further easing. For now, yield curve control will not be considered as long as interest rates can be managed through the Fed’s existing forward guidance and QE, for which they have indicated a preference.
- We expect the Fed’s purchases of U.S. Treasuries and strong forward guidance to allow U.S. yields to trade in a moderate range, with less volatility than at the start of the year. Additional volatility in yields could re-emerge as we approach the U.S. Presidential election. In the meantime, we expect the 10-year U.S. Treasury yield to trade in a range of 0.5% - 1.0%.