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Fed stays the course

April 29, 2021

changes in the federal funds target per year by monetary tightening cycle

Source: Federal Reserve Board of Governors

The FOMC left policy unchanged as expected yesterday while upgrading its assessment of the economy. The statement explicitly noted that the indicators have strengthened and that inflation has risen, but was otherwise virtually unchanged from that put out in mid-March. Jerome Powell was similarly steadfast in his post-meeting press conference, indicating that it is still not time to think about tapering asset purchases and stressing that persistent inflation is unlikely as long as slack remains in the labor market.

It is telling that the Fed’s messaging has been so little altered even in the face of surges in many of the growth statistics and widespread evidence of near-term inflation risks. While the small shift last month in the share of FOMC members expecting rate hikes in 2022 and 2023 could mark the beginning of a creeping hawkishness given the booming recovery and the potential for some transitory price pressures to be slow to dissipate (note Intel’s statement last week that the semiconductor shortage might last for two more years, for example), the ongoing dovishness is a strong sign that the pivot is going to be exceedingly drawn out. This would mirror the last cycle, in which the FOMC statement transitioned from flagging exceptionally low levels of the federal funds rate “for some time” in 2008 to “for a considerable period” in 2009 and 2010 to “at least through mid-2013” in 2011 to “for a considerable time after the asset purchase program ends” in 2012 and 2013. In the event, of course, QE was wound down in 2014 and the first rate hike didn’t come until late 2015. This recovery is a good bet to be quite a bit stronger than that one, admittedly, but it can also be argued that the current incarnation of the Fed has an even more dovish bent than that under either Ben Bernanke or Janet Yellen.

Moreover, it would come as little surprise should the actual tightening this time around prove as halting as that in the last decade. The Fed has moved at an increasingly gradual pace in recent cycles and the focus of late on augmented measures of unemployment suggests that the approach will remain cautious going forward. Consider that, based on the current levels of the federal funds rate and the 10-year Treasury yield and the historic relationship between the two during tightening cycles, it would take more than ten 25-basis point rate hikes from here to invert the curve. Should inflation remain as subdued as the Fed expects, then, it is shaping to be quite some time before financial conditions are restrictive and this nascent expansion is imperiled.

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