• Investment
  • 11 March 2021

Fed preview: Staying dovish

  • The Federal Open Market Committee meeting on March 16-17 will be significant given rising fears of inflation. But we expect the FOMC will remain dovish to the benefit of risk assets.
  • First, the Federal Reserve is likely to stress inflation will only rise temporarily above its 2% target this year - owing mainly to base effects.
  • Second, the central bank is set to keep its fed funds rate at 0.00-0.25% and give no signal it will taper its pace of quantitative easing yet.
  • Third, the Fed is likely to highlight labour market weakness for keeping interest rates unchanged long after the pandemic, and, last, it may still forecast no rate hikes before 2024.

The Federal Open Market Committee (FOMC) meets on March 16-17 amid rising fears of inflation. But we expect policymakers will remain dovish to the benefit of risk assets.

First, the FOMC is likely to stress inflation will only rise temporarily this year above its 2% target.

Last night, February’s consumer price index (CPI) was released showing core US inflation continues to be below the Federal Reserve’s 2% target at 1.3% (see chart). The central bank, however, expects inflation will exceed its 2% goal over the next few months owing to ‘base effects’.

Last year when the pandemic first emerged, consumer prices fell sharply in March and April as lockdowns began. The very weak readings from the spring of 2020 will cause inflation - the change in prices over the past 12 months - this year in March, April and May to appear exaggeratedly high.

The ‘base effects’ will push core inflation above 2% over the next few months. But the Fed will not react by raising its fed funds rate from 0.00-0.25% as the central bank expects inflation to fall back below its 2% goal over the next couple of years.

Thus, the FOMC is likely to stress again at this month’s meeting that temporary overshoots of its 2% inflation target will not cause the central bank to prematurely raise interest rates this year and undermine America’s recovery from the pandemic.

US Inflation

Source: Bank of Singapore, Bloomberg

Second, the FOMC is set to keep its very loose monetary policy settings unchanged this month.

The fed funds interest rate will remain at 0.00-0.25% and the Fed will not give any signal that it plans to taper its quantitative easing yet. Thus, the Fed will keep buying USD120 billion a month of US bonds to support the recovery. The FOMC is also likely to signal that if this year’s surge in 10Y Treasury yields from 0.90% to above 1.50% becomes disorderly and threatens the US recovery then it will act to calm the bond market.

Third, the Fed is set to highlight the weakness of the labour market for keeping interest rates at rock-bottom levels long after the pandemic. The US economy still hasn’t recovered 9.5 million of the 22.2 million jobs lost last year. Labour force participation also remains well below its pre-crisis levels at 61.4% compared to 63.4% before.

Last, the Fed will release new forecasts.

Each FOMC member provides estimates over the next three years for growth, inflation, unemployment, and the fed funds rate. The last FOMC forecasts in December showed the median projection - the average of the 16 FOMC members present at the meeting - anticipated the fed funds rate to remain at 0.00-0.25% throughout 2021, 2022 and 2023. We expect the median forecast will again show no rate hikes for the next three years given the Fed does not see inflation exceeding its 2% target on a sustained basis in 2021-2023.

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Version: July 2020