The Marriner S. Eccles Federal Reserve building in Washington, D.C.
Samuel Corum/Bloomberg“Don’t fire until you see the whites of their eyes” appears to be the new command from the Federal Reserve.
Any prospect—indeed even any discussion—of interest-rate increases or reductions in securities purchases by the central bank will depend on the Fed having its goals in sight, not just in its forecasts, Fed Chair Jerome Powell emphasized at a press conference on Wednesday. That doesn’t seem likely soon.
Powell’s comments were clearly aimed at heightened expectations that the Fed could raise rates multiple times by 2023, which in turn has lifted intermediate- and long-term Treasury yields. Those expectations pushed the benchmark 10-year Treasury yield to 1.68% at midday Wednesday, the highest level since January 2020. That benchmark yield eased back to 1.62% by the end of Powell’s press conference which, in turn, lifted stocks. The Dow Jones Industrial Average ended the day 0.6% higher and closed above the 33,000 mark for the first time.
Powell’s remarks followed the release of the Federal Open Market Committee’s policy statement, which, as universally expected, contained no changes in its near-zero federal-funds target or its $120 billion monthly purchases of Treasury and agency mortgage-backed securities.
Neither was it surprising that the Fed’s new Summary of Economic Projections contained significant upgrades to the central bank’s outlook for economic growth from its previous one released last December. Real gross domestic product is now expected to grow 6.5% in 2021, up from 4.2% previously, thanks to a boost from the recently enacted $1.9 trillion fiscal package. Similarly, the panel’s projection for unemployment is lowered and its expectation for inflation was increased slightly. Forecasts for 2022 and 2023 also were tweaked.
But the main message Powell conveyed was clear: The Fed will continue to maintain its ultra-accommodative policy until the monetary authorities are convinced its policy goals are in sight. That would mark a sharp departure from the practice of monetary policy for more than a generation.
The accepted modus operandi has been for the Fed to head off an increase in inflation by pre-emptively tightening monetary policy when what it considered to be full employment was in its forecast. Not only did the Fed’s target for full employment keep changing—falling from 6%, to 5%, and so on until the jobless rate hit 3.5% in early 2020 before the pandemic--but inflation continuously fell short of the Fed’s 2% target.
While the Fed’s so-called dot plot of rate expectations showed seven out of 18 FOMC members anticipated an increase in the fed-funds rate in 2023, Powell continually took pains to say those are only estimates of where the individual Fed governors and district presidents think the rate might be based on their individual forecasts. Not only is that a long ways off in the future, Powell noted, but the forecasts are even more uncertain than usual.
Meanwhile, the Fed will be keeping its foot down on the monetary gas pedal. Financial conditions remain extremely accommodative, as indicated by the Dow’s record, plus still historically low interest rates and tight credit spreads, which Powell called appropriate. What would be worrisome would be if financial conditions became disorderly.
Powell didn’t think any change in the Fed’s bond purchases were needed in the face of higher yields at the long end of the Treasury market. He called the central bank’s purchases across the yield curve as appropriate and didn’t see the need to skew its buying to try to pressure longer-term yields lower. Some central banks abroad, notably the Reserve Bank of Australia, have tried to manipulate bond markets by shifting their purchases.
Even with the headline measures of unemployment expected by the Fed to drop from 6.2% last month to 4.5% by year-end and 3.9% by the end of 2022, Powell emphasized that the total number of jobs remains more than 9 million below where it stood before the pandemic. Inflation also would have show more than a transitory rise from the depressed levels of a year ago, and stay above the 2% target for some time for the Fed to change its stance.
Keeping Fed policy easy while the economy recovers clearly is bullish for financial markets. “It would be hard to craft a more constructive statement than this,” a client note from Evercore ISI asserted.
But this policy of maintaining zero rates and huge bond purchases, even as the economy recovers, is an experiment playing out in real time. The mantra had always been that monetary policy works with long and variable lags. That produced four decades of disinflation.
Waiting until the Fed sees the whites of inflation’s eyes will be a test of this new experimental approach.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
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March 18, 2021 at 06:22AM
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The Fed Will Wait. That’s a Positive for Stocks and a Departure from the Past. - Barron's
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