Fed to keep rates at near-zero until 2023 and beyond - Capital Economics
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Fed to keep rates at near-zero until 2023 and beyond

US Economics Update
Written by Paul Ashworth
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The FOMC’s updated economic and rate projections show that officials expect to leave the fed funds rate at near-zero until at least 2023 and probably well beyond that. With the five-year Treasury yield already at less than 0.2%, however, those projections were already largely priced into the market. In the statement released after today’s policy meeting, the FOMC updated the language to bring it into line with its recent adoption of a flexible average inflation target. But those changes were a little more hawkish than we had expected, and the Fed offered no hints that it would be willing to back up its new policy framework with an imminent expansion of its large-scale asset purchases.

  • The FOMC’s updated economic and rate projections show that officials expect to leave the fed funds rate at the current near-zero rate until at least 2023 and probably well beyond that. With the five-year Treasury yield already at less than 0.2%, however, those projections were already largely priced into the market. In the statement released after today’s policy meeting, the FOMC updated the language to bring it into line with its recent adoption of a flexible average inflation target. But those changes were a little more hawkish than we had expected, and the Fed offered no hints that it would be willing to back up its new policy framework with an imminent expansion of its large-scale asset purchases.
  • The new statement clarifies that “with inflation running persistently below” the 2% longer-run inflation target, the FOMC “will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time.” That is in line with the revisions to the long-run goals and strategy statement unveiled by Chair Jerome Powell in his recent Jackson Hole speech.
  • To achieve that the Fed now expects to leave the policy rate at near-zero “until labour market conditions have reached levels consistent with the [FOMC’s] assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.” It is that last bit that strikes us as a little hawkish. We had expected the Fed to go further and say it wouldn’t raise rates until the target had been sustainably achieved, which was the language that Neel Kashkari dissented in favour of. But instead inflation only needs to be “on track” to exceed the target for “some time”. Even that was too much for Robert Kaplan, who also dissented, preferring a less explicit form of forward guidance. Based on past comments by Fed officials, we would interpret a “moderate” overshoot to mean 2.5%.
  • Looking at the latest updated economic and rate projections, all but four officials expect the fed funds rate to still be near-zero at the end of 2023. And with the median forecasts showing that inflation will continue to undershoot the target for several more years and won’t get back to 2% until 2023, the new framework implies that the Fed would probably wait another year or two or more before beginning to normalise the policy rate, even though the unemployment rate is expected to be back down to 4.0% by end-2023.
  • The Fed also slightly reframed its pledge to continue purchasing Treasury securities and agency-backed securities “at least” at the current pace, which equates to about $80bn of Treasuries and $40bn of MBS per month. The new language clarifies that, as well as promoting smooth market functioning, the purchases are also fostering accommodative financial conditions and supporting private credit growth. But there were no hints that the Fed would either expand the overall pace of its purchases or focus those purchases on the long end of the yield curve. With the forward guidance already pinning down the short end, the Fed could get more bang for its buck purchasing longer-dated bonds. (See Chart 1.)
  • Overall, the modest changes introduced today would seek to justify the view that the Fed’s new framework represents an evolution rather than a revolution. Inflation expectations have recovered to pre-pandemic levels, but that appears to be due to the faster-than-expected recovery in the real economy rather than the adoption of the flexible inflation target. (See Chart 2.)

Chart 1: Treasury Yields (%)

Chart 2: Breakeven Inflation Compensation (%)

Source: Refinitiv