The Federal Reserve’s July meeting minutes disappointed by giving little new insight into the central bank’s ongoing monetary policy review and its implications for how long the fed funds interest rate will be kept at 0.00-0.25%.
The Federal Open Market Committee (FOMC) wants more time to discuss how officials should guide expectations of future interest rate moves.
‘A number of participants noted that providing greater clarity regarding the likely path of the target range for the federal funds rate would be appropriate at some point.’
But the FOMC still seems poised to conclude its review at its next meeting in September and shift to a more dovish strategy of targeting inflation to be 2% on average over the business cycle - rather than just hitting 2% inflation from time to time as it has over the past decade (see chart).
The minutes said changes to the Fed’s Statement on Longer-Run Goals and Monetary Policy Strategy should be finalized ‘in the near future.’
A shift to average inflation targeting implies the Fed would aim to overshoot its 2% inflation target over the next few years to make up for the last few years where inflation has consistently fallen short of 2%.
To do this the FOMC is set to tie future interest rate hikes to inflation first returning to its 2% goal or for unemployment to fall to much lower levels than its current rate of 10.2%.
Thus, the central bank would strengthen its ‘forward guidance’ by committing to only lifting the fed funds rate from its current near zero levels when the US economy has recovered sufficiently to meet clear thresholds on firmer inflation and lower unemployment.
The Fed, however, does not seem ready yet to follow the Bank of Japan and the Reserve Bank of Australia in formally capping the levels of Treasury yields - though policymakers left the option open for the future.
‘Many participants judged that yield caps and targets were not warranted in the current environment but should remain an option that the Committee could reassess in the future if circumstances changed markedly.’
In short, July’s meeting minutes show that the Fed still seems likely to shift to a more dovish strategy that may result in the central bank not raising interest rates for up to the next five years. This would be a major change in the Fed’s stance particularly for the central bank to tolerate modest overshoots of its 2% inflation target over the next few years without raising interest rates in a sustained cycle.
We therefore expect the current market trends of a weaker USD, very low US government bond yields, buoyant equities and record gold prices to remain underpinned by a very dovish Fed.
We forecast the EUR to rise to 1.25 over the next year and for 10Y US Treasury yields to only pick up moderately to 0.90% over the same period.Disclaimer applicable to recommendation
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