The updated economic projections released after the Fed’s mid-March meeting show that officials expect strong economic growth this year to have only a transitory impact on inflation, which explains why most still aren’t thinking about thinking raising interest rates. Even if inflation proves more stubborn, we expect their new framework will allow them to justify leaving rates unchanged over the next few years.
- The updated economic projections released after the Fed’s mid-March meeting show that officials expect strong economic growth this year to have only a transitory impact on inflation, which explains why most still aren’t thinking about thinking raising interest rates. Even if inflation proves more stubborn, we expect their new framework will allow them to justify leaving rates unchanged over the next few years.
- Alongside leaving the policy rate on hold at 0.00-0.25% and the pace of asset purchases unchanged at $120bn per month, the Fed made minimal adjustments to the post-meeting policy statement. The only significant change was that economic activity and employment were noted to have “turned up”. There was no acknowledgment of the improving virus situation, vaccine rollout or additional fiscal support.
- The accompanying updated economic projections were more revealing. Economic growth is now expected to be 6.5% this year (up from 4.2% in December’s forecasts) with forecasts for future years little changed. That additional economic activity translates into a slightly lower profile for the unemployment rate, with the median projection at 3.9% for end-2022 (4.2% previously) and 3.5% by end-2023 (from 3.7%). Even with its new broad and inclusive employment goal, that sounds close to full employment to us.
- Crucially for the policy outlook, however, the Fed does not see that feeding through to markedly stronger inflation. While the forecast for end-2021 was raised to 2.4% for headline PCE (from 1.8%), both headline and core inflation are projected to drop back to 2.0% in 2022 and rise only slightly to 2.1% in 2023. In the post-FOMC press conference, Chair Jerome Powell cited base effects and a combination of rebounding spending and supply bottlenecks as reasons why inflation would be temporarily higher this year. But he also said that would not suggest inflation was “on track to moderately exceed 2 percent for some time”.
- As a result, it is little surprise that the median rate projection remained at near-zero through the end of 2023. (See Chart 1.) The dot plot showed four officials pencilling in hikes in 2022 while seven expect rates to rise in 2023, up from one and five respectively in December. But that is to be expected given the diversity of views on the committee, particularly among the regional Fed presidents. Powell stressed that “the largest part of the committee by far” is still projecting rates on hold through end-2023.
- Powell also argued it was too soon to discuss tapering asset purchases, underlining the commitment to wait for “substantial further progress” towards the Fed’s goals. At the same time, the Fed signalled no intention of adjusting the program to counter recent increases in longer-term Treasury yields. Powell repeated the line that while disorderly moves would be unwelcome, financial conditions are accommodative.
- The key risk to the Fed’s forecasts is that the increase in inflation this year proves more enduring than officials currently expect. Surveys suggest rising price pressures are broad-based, wage growth is elevated given the spare capacity in the labour market, and inflation expectations have trended higher over the past year, all of which suggests that inflation won’t necessarily drop back as the Fed anticipates. (See Chart 2.) Even if inflation does continue rising, however, we suspect that officials will use the flexibility provided by its new average inflation target and “broad and inclusive” employment goal to justify leaving rates on hold.
Chart 1: Fed Funds Rate Expectations (%)
Chart 2: Core PCE Inflation (%)
Sources: Refinitiv, Fed, WSJ, Capital Economics
Michael Pearce, Senior US Economist, email@example.com