US monetary policymakers have left key interest rates in the world’s largest economy at rock-bottom levels and indicated higher policy rates are still several years away. Chair Powell again stressed fiscal policy will be crucial in providing support to households and businesses hit by pandemic-induced restrictions on activity.
The Federal Reserve’s (the Fed’s) decisions at its last policy meeting of 2020 was in line with market expectations. It clarified its guidance over the central bank’s quantitative easing (QE) programme aiming to keep market rates low and provide ample liquidity. The Fed’s decisions do not fulfill calls for a more forceful monetary stimulus to bolster the fragile recovery by lengthening the average maturity of its bond purchases or increasing the aggregate size.
The Fed said it would keep buying financial assets at least at the current monthly rate – that is, USD 80 billion worth of US Treasury bonds (USTs) and USD 40 billion of mortgage-back securities (MBS). These levels would be maintained until there had been ‘substantial’ further progress toward full employment and the Fed’s 2% inflation target. The US unemployment was 6.7% in November. Inflation in the US remains low with the US Consumer Price Index (CPI) all items rising just 1.2% over the year to November (see graph below).
The Fed did not say what constitutes ‘substantial’ further progress. It could be taken to mean regaining 6-7 million of the 10 million jobs the economy is still short as a result of the impact of COVID. Under reasonable assumptions about the outlook for the economy, that might take until mid-2022, meaning the Fed could start to taper the size of its QE programme later that year. In November, a NY Fed survey of primary dealers found that downsizing QE could begin in early 2022.
According to the Fed’s latest forecasts, core inflation could hit 2% and the unemployment rate could fall to below 4% at the end of 2023, yet only five of the 17 people on the rate-setting committee felt those conditions would meet the Fed’s criteria to raise rates for the first time. The forecasts showed that all 17 expected no change in key rates throughout 2021, with a large majority foreseeing that the fed funds rate would remain in its current 0.0-0.25% band for another two years after all (see below).
Echoing the dovish message in the Fed’s forecasts, chair Jerome Powell reminded the press conference that the Fed was currently aiming for an inflation overshoot. He emphasised there were still significant disinflationary forces at work around the world and that it was not going to be easy to get core inflation to move up.
Similarly, he poured a lot of cold water on the idea that the Fed would react to a potential surge in inflation in the summer of 2021 when pent-up demand for holidays, entertainment and similar activities could be expected to be released.
Powell endorsed the idea that Congress should continue to work on passing another sizeable fiscal package, noting that consumer spending had benefited significantly from the extension of unemployment benefits and direct cheques to households that had been part of the fiscal stimulus this spring. Both measures are under consideration by Congress for inclusion in a pre-Christmas bill.
Senior Republicans and Democrats have indicated that meaningful progress is being made on stimulus deal, which was already a topic of debate before last month’s presidential election.
At this point, we believe it would be more surprising to markets if the initiative were to collapse than if it passes. Media reports have put the price tag at around USD 900 billion. In a change from the USD 780 billion plan released by a bipartisan group of Senators earlier this week, there would be a new round of direct payments to households.
Unless Democrats can win both the runoff elections for Senate seats in Georgia on 5 January, we believe this round of fiscal stimulus is likely to be the last to tackle the pandemic.
In that case, a further steepening in the bond yield curve and/or another run-up in equity prices will, in our view, hinge primarily on GDP growth beating consensus expectations in 2021 rather than in response to a further policy push to generate more growth.
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