Fed Feeling the Luck of the Irish

The Federal Open Market Committee (FOMC) voted unanimously to keep interest rates near zero and asset purchases at the current level of $120 billion, $80 billion in Treasury bonds and $40 billion in mortgage-backed securities. The statement after the meeting concluded today was little changed but the forecasts, which were upgraded since last December, have changed a lot. The forecasts now include the two full rounds of fiscal stimulus since the December meeting, totalling $2.8 trillion, and a much faster ramping up of vaccinations than in December. The shifts show.

The FOMC is now expecting the economy to expand at 6.5% on a fourth quarter to fourth quarter basis; that is 2.3% higher than December; members had assumed more modest stimulus from the federal government then.

The forecasts for inflation have moved higher. The FOMC now expects inflation to exceed its 2% target for both the core and overall personal consumption expenditures (PCE) index in 2021 and 2023. The assessment of risks has moved lower. Most participants have either downgraded the risks to balanced, or moved into the upside column of the forecast.

Most participants during the meeting still expect the Federal Reserve to wait to raise rates until after 2023. However, the number of participants expecting a rate hike much sooner has risen from one to four in 2022 and from five to seven in 2023. This is the first official forecast in which Fed Governor Christopher Waller has participated; there are 18 participants now at each FOMC meeting. Waller is a known dove; it appears that he is looking for a lower neutral rate than his colleagues.

Fed Chairman Jay Powell tempered his colleagues’ more hawkish tone shown in the Fed’s forecasts with the majority view that:.

1. Any inflation we see in 2021 will likely be transitory, reflecting the deceleration in inflation we saw last year, which makes year-on-year gains easier this spring. We are likely to see temporary supply shocks associated with a surge in demand. Airfares and hotel room rates are likely to flare as demand surges; the Fed views those increases in inflation as one-offs related to the need to ramp up growth.

2. The Fed is still waiting to see full and more inclusive employment gains before thinking about raising rates.

3. The Fed would like to see a more persistent but modest overshoot in inflation before raising rates; officials want inflation to reach 2% and be on track to exceed inflation for a while before raising rates.

Powell shares the optimism of his colleagues but wants to see that optimism realized. We have had too many false starts for the FOMC to move preemptively given the hole we are still in with regard to employment. Powell reiterated again that we are still nearly 10 million jobs in the hole from the onset of the crisis a little over a year ago. He also noted that the Fed is not going to be raising rates for some time.

Powell would not comment directly on the recent rise in Treasury bonds. He underscored that measures of financial conditions remain extremely accommodative. He dodged talking about any potential changes to the asset purchase program. His goal was to dampen speculation regarding efforts to target the yield curve. (He also didn’t rule anything out.)

Powell reiterated his commitment to look at the gap in employment between white workers and people of color to determine slack in the economy. He has made it clear how the recession has hit low-wage, Black and Hispanic workers harder than other parts of the population. He would like to see a large improvement in the employment situation for those workers.

He was clearly relieved that fiscal policy has removed some of the burden of the recovery from the Fed’s shoulders and alleviated the risks of more permanent scarring in the labor market. He underscored the need to invest in people, which is something Congress can do but the Fed cannot.

Bottom Line
The Fed has displayed a hint of optimism for the first time in a year. That is good news. Members will not act, however, on optimism alone. The Fed needs to “see” a major improvement in the economy and a persistent overshoot on inflation to prompt it to actually pull the trigger and raise rates. The Fed’s resolve to be patient on inflation will be tested as it gets into 2022. We could begin to see dissents with regard to rate hikes as we move into 2022, given the shift in the ranks of those looking for a rate hike next year.

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