Overnight, the Federal Reserve kept its fed funds interest rate unchanged at 0.00-0.25%, its pace of quantitative easing also the same at USD120 billion a month of bond buying and reiterated its very dovish stance on monetary policy.
First, the Federal Open Market Committee (FOMC) continued to stress the near-term uncertain outlook caused by the pandemic: ‘the path of the economy will depend significantly on the course of the virus, including progress on vaccinations. The ongoing public health crisis continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook.’
Second, the FOMC sharply upgraded its long-term forecasts as the US economy recovers but the majority of the FOMC still project no hikes in the fed funds rate over the next three years.
The FOMC now expects GDP to expand by a very strong 6.5% in 2021 as the pandemic eases. Unemployment is also projected to return to pre-crisis levels of 3.5% by 2023. This will result in core inflation - currently still below the Fed’s 2% target at 1.5% as the chart shows - rising to 2.2% this year and remaining at or slightly above the Fed’s 2% goal for 2022 and 2023. But despite strong growth, labour market recovery and marginally above-target inflation, the majority of the FOMC continues to forecast the fed funds rate will remain unchanged at 0.00-0.25% in 2021, 2022 and 2023.
Source: Bank of Singapore, Bloomberg
Last, the Fed gave no signal it was ready to start tapering its quantitative easing yet.
We think the central bank will not reduce the pace of its bond buying until 2022 nor raise interest rates until 2024, a very dovish stance that supports risk assets while weakening the USD (our 12 month forecasts for the EUR and CNY are 1.30 and 6.15). The Fed is pursuing a new strategy of seeking inflation to average 2% over the business cycle. Thus, the FOMC is now willing to tolerate modest overshoots of its 2% target to make up for prior years when inflation has fallen short of 2%
The Fed sees this year’s likely rises in inflation - due to the economy re-opening and to the base effects of last year’s weak readings in March and April no longer being included in year-on-year comparisons of consumer prices - to only cause a modest overshoot of its 2% goal. Instead the central bank expects the labour market will still take several years to fully recover from the crisis, keeping a lid on wage growth and inflation.
In the next few months, the Treasury market is still likely to be volatile. Fed Chair Jay Powell did not push back on this year’s surge in 10Y yields from 0.90% to over 1.60% noting ‘financial conditions [are still] highly accommodative.’ In addition, 7 of the 18 FOMC members forecast fed funds to rise in 2023, reinforcing fears the central bank could still bring forward rate hikes. But we expect the Fed’s leadership to stay very dovish and not react to minor inflation overshoots before 2024.Disclaimer applicable to recommendation
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