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Fed Telegraphs Low Rates Through 2023 – and Beyond

Karl Schamotta September 16, 2020

Policymakers at the Federal Reserve expect to leave interest rates near zero for at least three years, and are aiming for higher levels of inflation as they seek to strengthen the US labor market and economy.

In the official policy statement, released at 2:00 Eastern time, members of the Federal Open Market Committee left all of the central bank’s major monetary policy levers untouched, and provided a form of “forward guidance” meant to keep interest rates anchored into the future. Language shifted from a commitment to maintain rates close to zero until policymakers are “confident that the economy has weathered recent events” to when “labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time”.

In a reflection of their newly-adopted policy framework, policymakers said they will no longer assess economic conditions relative to the central bank’s  “maximum employment objective and its symmetric 2 per cent inflation objective”, and will instead “aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent”.

In the accompanying economic projections, members of the rate setting committee turned more optimistic on the economy, noting an improvement in financial conditions, employment, and economic activity since the June meeting. The jobless rate is now expected to fall to 7.6% by the end of the year, well below the 9.3% forecast in June. Output is seen shrinking -3.7% for the full year – much smaller than the -6.5% hit previously anticipated. And core personal consumption expenditure inflation (generally understood to be the Fed’s target inflation benchmark) will rise to 1.2% from the previously-estimated 0.8%.

But medium-to-long term projections remained relatively depressed, with the unemployment rate falling gradually from 5.5% in 2021 toward 4.0% in 2023 – stubbornly remaining above pre-pandemic levels. Real growth is expected to drop through the forecast period, from 4% in 2021 down to 2.5% in 2023.

Inflation is expected to move up from 1.7% next year to 2% in 2023, and interest rates are projected to remain at zero through the end of the forecast.

During the press conference following the decision, Chairman Powell emphasized the importance of the shift toward formal forward guidance, saying “these changes clarify our strong commitment over a longer time horizon”, but refused to be drawn on the precise definition of words like “maximum employment”, “moderately”, or “over time”. When asked about changes in the bank’s asset purchase program, Mr. Powell carefully avoided communicating anything substantive – leaving markets to bid up inflation breakevens and the dollar.

He also made it clear that policymakers are keenly aware of – and keenly aware of the need to communicate – the central bank’s limitations. With the capacity to lend money, but not spend it, the Fed cannot provide direct stimulus to the households and small businesses suffering the most under current conditions. Toward the close of the Powell noted that Washington’s initial response was “rapid and effective”, but also said “My sense is that more fiscal support is likely to be needed”.

Taken in sum, it is clear that the Fed remains convinced that the US economy is facing a difficult and protracted recovery, with uncertainties surrounding government support, the presidential election, and the evolution of the pandemic itself – and, given that there’s significant daylight between that view and the perspective currently embedded in markets, volatility levels could stage a rebound in the months to come.
Karl Schamotta
Chief Market Strategist

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