Fed to re-emphasize current strategy while raising economic forecasts

 

At its FOMC meeting this week, the Fed is expected to maintain its current policies of zero interest rates and sizable purchases of Treasuries and MBS, and re-emphasize the importance of sustaining such monetary accommodation to support the recovery in the economy and labor markets. The Fed will update its quarterly Summary of Economic Projections (SEPs), we expect it will significantly increase its projection of GDP growth and projecting that a rise in the Federal funds rate would be appropriate in 2023. In the press conference, Fed Chair Powell is likely to say that while the economy is recovering, employment and labor markets lag well behind. Regarding financial markets, we expect he will note that inflation remains tame and the recent backup in rates suggests that the Fed’s policies are on the right track.

 

In summary:

 

*In its Policy Statement, the Fed is expected note that economic conditions are improving and maintain its stance that its current policies are necessary to support the recovery. The statement iss unlikely to indicate that the Fed intends to modify its net new $80 billion per month purchases of Treasuries and $40 billion of MBS anytime soon.

 

*In its SEPs, the Fed is expected to significantly raise its forecast of real GDP growth for Q4/Q4 2021 from 4.2%, its December forecast to reflect the stronger economic activity and incorporate recent fiscal stimulus legislation. The median FOMC projection may be 5.5%-6%. The Fed likely will maintain its December forecasts of the unemployment rate of 5.0% at year-end 2021 and 4.2% at year-end 2022, based on the assumption that unemployment falls but labor force participation rates rise.

 

*The Fed likely will tweak up its projections of the core PCE inflation by a tenth each in 2021 and 2022, to 1.9% and 2.0%, and raise its headline inflation projections for 2021 to reflect higher oil/energy prices.

 

*The Fed is expected to project that it is appropriate to raise its Federal funds rate target in 2023. In the December SEPs, the median Fed member had forecast that it would be appropriate to keep the policy rate unchanged at zero through 2023, although five FOMC members has indicated that one rate hike in 2023 would be appropriate. Currently, the futures markets predict two rate hikes of 25 basis points in 2023. The ever-dovish and cautious Fed is unlikely to go that far, although the “dot plots” may indicate that several FOMC members think several rate hikes would be appropriate, and one or more may indicate that a rate increase in 2022 may be appropriate.

 

*While markets focus on the rise in bond yields and some participants are concerned about inflation risks, in his post-FOMC meeting press conference, Powell is expected to note that the rise in market-based expectations of inflation and bond yields confirm that the Fed’s ultra-easy monetary policy is working. He will likely repeat the Fed’s new strategic framework that the Fed favors higher inflation.

 

Mickey Levy, mickey-levy@berenberg-us.com

 

 



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