The Federal Reserve will continue pumping monetary stimulus into the financial system, keeping markets flooded with cash – even as a vaccine-led recovery gains momentum in the world’s largest economy.
What happened: Following the conclusion of its latest two-day policy meeting, the Federal Open Market Committee held benchmark interest rates near zero and said that the bank would continue to buy $120 billion in securities every month “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”
In the accompanying statement, officials turned more optimistic on the economy, replacing a sentence suggesting that the ongoing health crisis represented a “considerable risk”, with one acknowledging that risks “remain”. “Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened,” the statement said, “The sectors most adversely affected by the pandemic remain weak but have shown improvement”.
Price risks were downplayed: A single sentence said, “Inflation has risen, largely reflecting transitory factors”, and – in comments during the press conference – Chairman Jerome Powell said that sustained inflationary pressure was unlikely to come before substantial slack in the labor market disappears.
Tapering concerns were also brushed off: Powell said that it was “not time yet” to start talking about talking about a reduction in asset purchases, and that it would be “some time” before the central bank felt confident in the economy’s path.
And yet: Throughout the announcement and press conference, officials maintained what might be called a “constructively ambiguous” approach to policy, avoiding definitions of “substantial progress”, “maximum employment” and “transitory”, while dodging repeated attempts to quantify the Fed’s reaction function. This mean that a tug-of-war will continue in markets as investors struggle to determine what might trigger a tapering in asset purchases – or when the Fed will begin thinking about thinking about raising rates. Periodic volatility spikes in interest rates and currency markets look likely to continue.
Bottom line: Yet another Fed decision has kept markets convinced that the global liquidity tide will continue to rise. Investors now expect tapering to begin in early 2022, with rates only beginning to climb in 2024 or 2025 – enough to put the dollar on the defensive and wind in the sails of risk assets around the world. Commodity-linked and emerging markets currencies are rallying along with key equity indices, and the euro is pushing higher as we go to pixels.
What’s next: President Biden is scheduled to speak to Congress this evening, setting out a new $1.8 trillion plan to bolster the US safety net. Although the proposal would be funded by tax increases on the wealthiest Americans (and might dampen risk appetite accordingly), implications for the currency markets are likely to be modest.
Chief Market Strategist
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