The Federal Reserve kept its fed funds interest rate unchanged at 0.00-0.25% and maintained its quantitative easing at USD120 billion a month of bond buying. The Fed also reiterated its dovish view that inflation increases above its 2% target this year will only be temporary, noting: ‘inflation has risen, largely reflecting transitory factors.’ The central bank, however, made hawkish tweaks to its overall stance that surprised financial markets.
First, Chairman Powell confirmed policymakers had begun discussing when to start tapering quantitative easing as the US economy recovers, saying: ‘it will be appropriate to consider announcing a plan for reducing our asset purchases at a future meeting.’
Second, the Federal Open Market Committee updated its forecasts with 13 of the FOMC’s 18 members now projecting the fed funds rate to start rising in 2023 compared to just 7 previously. In addition, 7 of the 18 policymakers now see the first Fed rate hike likely occurring as early as 2022 while the median projection for 2023 - the average of the 18 FOMC members - is for two 25bps increases in the fed funds rate not just one.
We had expected the Fed to hawkishly tweak its dovish stance. But the changes still jolted Treasury yields higher as the chart shows with 10Y yields jumping from 1.49% to 1.57%. Similarly, the USD rose across the board with the EUR falling to 1.20. But despite its tweaks, the central bank’s overall outlook continues to be dovish.
Source: Bank of Singapore, Bloomberg
The Fed remains determined to avoid a repeat of the 2013 taper tantrum. Thus, its statement reiterated ‘substantial further progress’ was needed towards meeting its goals of maximum employment and stable 2% inflation before the Fed would slow its bond buying. Powell also stressed the central bank would give ‘advance notice’ before it tapers its quantitative easing. We thus expect the Fed’s ‘taper talk’ will last for months before the central bank only starts lowering its bond buying from early 2022.
Similarly, we think the Fed may wait until as late as 2024 before hiking interest rates. Though the central bank’s forecasts or ‘dots’ now anticipate rate rises from 2023, Powell downplayed the changes noting: ‘the dots are not a great forecaster of future rate moves … it is because it's highly uncertain … so the dots should be taken with a big grain of salt.’ Moreover, the Fed’s forecasts for core inflation were raised sharply for 2021 from 2.2% to 3.0% but in 2022 and 2023 the FOMC projects core inflation will fall to 2.1%. With inflation back at its 2% target, the Fed could thus delay rate hikes before 2024 if it hasn’t achieved its other goal of securing maximum employment.
We expect the Fed’s overall dovish outlook will keep supporting risk assets this year. We forecast 10Y yields will gradually rise to 1.90% over the next 12 months as the Fed starts tapering but remain at historically low levels. We also see the USD weakening again as the lack of Fed hikes in 2022 and 2023 keep real US interest rates negative.
