The body that determines Monetary Policy, the Federal Open Market Committee (FOMC), concluded a regularly scheduled two-day meeting two weeks ago and to no one’s surprise, decided to leave interest rates unchanged.
Despite this lack of movement and given the massive amount of government stimulus, widespread application of a COVID-19 vaccine and the recent pick-up in economic activity, investors and market pundits were watching the post-meeting press conference closely to see if Federal Reserve Chairman Jerome Powell might provide some insight as to when the Fed might begin to tighten monetary policy by initially slowing down their purchase of mortgage-backed securities and U.S. Treasuries and then eventually raising interest rates.
It is important to note that by most measures the U.S. economy is recovering rapidly from the pandemic induced economic slowdown. In fact, Powell noted that “widespread vaccinations, along with unprecedented fiscal policy actions, are also providing strong support to the recovery. Indicators of economic activity and employment have continued to strengthen, and real GDP this year appears to be on track to post its fastest rate of increase in decades.” Also, after the meeting the Fed increased its projection of GDP growth for 2021 from 6.50% to 7.00% but also raised its forecast on inflation from 2.40% to 3.40%. It is also important to note that the Fed adheres to a dual mandate when executing monetary policy which is to pursue of level of maximum employment along with price stability.
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Prior to an economic symposium sponsored by the Kansas City Fed during August of 2020, the “price stability” component of that mandate referred specifically to an inflation target of two percent. However, at this meeting Powell broadened that target to one which “will seek to achieve inflation that averages 2 percent over time,“ and in so doing has allowed for more subjectivity and flexibility as to how the Fed interprets and ultimately responds to economic data.
In a somewhat hawkish tone, Chair Powell noted that “while reaching the standard substantial further progress is still a ways off, participants expect that progress will continue. You can think of this meeting at the talking-about-talking about meeting, if you like.” Powell was referring to bond purchases when he made the talking-about-talking about tapering statement, a policy tool that will be a headwind to economic growth.
Powell also stated that “as the reopening continues, shifts in demand can be large and rapid, and bottlenecks, hiring difficulties and other constraints could continue to limit how quickly supply can adjust – raising the possibility that inflation could turn out to be higher and more persistent than we expect.”
Other members of the FOMC also made their voices heard. At the most recent meeting, 13 of 18 members believe the Fed will increase the Federal Funds Rate in 2023 as compared to only 7 at their March meeting while 7 believe the Fed will hike next year, this as compared to only 4 at the March meeting.
These notes struck by the Fed pushed the overall stock market lower, led by financials and cyclicals while secular growth stocks outperformed. Then, this past week, markets appeared to shake-off the Fed talk by surging higher. So now, we watch, wait and wonder if the Fed will just talk-the-talk or eventually walk-the-walk by raising rates.
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