- The Fed will be more tolerant of inflation in hopes of maximizing employment
- The Fed will continue aggressive asset purchases and low rate targets
- The Fed believes that additional Federal stimulus is necessary for recovery
Rates will not be increased until 2023! This was the takeaway headline we heard repeated ad nauseum last week in the financial media after Federal Reserve Chair Jerome Powell spent an hour at the podium reviewing the new FOMC policy statement. Our takeaway from the meeting was not so simple. Perhaps a better way to summarize the meeting is, “Fed Continues Active Intervention, Rates Lower for Longer, Other Help Needed.”
When thinking about the Fed, it helps to keep in mind its dual mandate, the two primary goals of maximum employment and price stability. In an historically low-rate environment like today, these are somewhat opposing forces. The Fed has taken an extremely accommodative stance during the pandemic, keeping rates low and injecting liquidity in hopes that the flow to businesses and households will maintain jobs that can be saved by running out the clock on the virus. A natural question arises from these actions: will this accommodation lead to inflation and require the Fed to reverse course? The Fed rarely speaks as plainly as it did in this quote from their policy statement:
“We view maximum employment as a broad-based and inclusive goal and do not see a high level of employment as posing a policy concern unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals.”
Chairman Powell would surely protest, but we believe a fair restatement here is, “We will not worry about inflation until we see it happening. Until then jobs are our #1 concern.” We come to this understanding in context, as the Fed employed some voodoo in August by editing their long-term inflation strategy to say that they seek to “achieve inflation that averages 2 percent over-time.” In other words, it’s okay that inflation is low for a prolonged period as we dig ourselves out of this recession, because we can overshoot 2 percent inflation and still achieve a 2 percent average. Eight of ten FOMC members signed off on the statement that rates won’t be raised until inflation is “on track to moderately exceed 2 percent for some time.”
The Fed estimates it won’t be until 2023 that low unemployment and rising inflation would require a rate hike. This “forward guidance” was the new tool invented in the recovery from the financial crisis. Essentially, if they take rates to the floor and have no more cuts available, they can be more accommodative by indicating cuts won’t happen for some time. In my mind the effectiveness of guidance this long-term is similar to issuing additional life-sentences to a death row inmate; how much can it possibly change behavior?
It seems the Fed knows that saying “lower for longer” isn’t a panacea cure, and Chairman Powell referenced the need for outside help from Congress in the Q&A. He highlighted that household spending has recovered ¾ of its spring decline, largely aided by federal stimulus and increased federal unemployment, and that most forecasts of an ongoing recovery are pricing in substantial additional fiscal support. Thus, the Fed will continue to expand its balance sheet, but the experts believe a second round of stimulus is needed to maintain the recovery.
Fed Policy Statement, Sept 16, 2020
Fed Press Conference Transcript, Sept 16, 2020