First Statement: on Longer Run goals and Monetary Policy
Some important highlights for me were:
- Fed acknowledges that monetary policy is no longer the “go to”policy for maintaing employment
“The Committee judges that the level of the federal funds rate consistent with maximum employment and price stability over the longer run has declined relative to its historical average. Therefore, the federal funds rate is likely to be constrained by its effective lower bound more frequently than in the past. Owing in part to the proximity of interest rates to the effective lower bound, the Committee judges that downward risks to employment and inflation have increased.”
What does this mean? It means that when you hit zero, the Fed can’t do anymore and the fiscal side has to step in.
“The Committee is prepared to use its full range of tools“
When rates hit zero, the Fed is prepared to QE to support employment.
2. FOMC Statement:
Rates remain unchanged for now. Pandemic is still the main source of economic disruption, and one of the main sources behind supply bottlenecks and inflation.
“Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation.”
This was a good sign and not unexpected by the markets. Inflation expectations have come down, supply constraints easing will bring down inflation.
What does the Fed hope will happen? That as better economic conditions persist, they can raise rates and normalise the balance sheets without hurting the economy. So the bet is that the virus situation will improve. Either we vaccinate and medicate our way out, or a less fatal strain appears, which is highly likely. Which is why Powell goes on to say “Risks to the economic outlook remain, including from new variants of the virus.”
“The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March”
In line with expectations, but a little bit more accelerated.
3. On balance sheet normalization:
“reducing the size of the Federal Reserve’s balance sheet will commence after the process of increasing the target range for the federal funds rate has begun”
Best case scenario: Rates rise to 1%, then taper begins.
Most likely scenario: Rates rise once in March, and then the taper schedule begins together.
Summary:
Long term, the Fed knows that monetary policy is becoming increasingly ineffective in acheiving it’s goals.
Shorter term, the Fed will end asset purchases in March, albeit at a faster pace than was expected.
Regarding inflation, the Fed acknowledges both supply and demand imbalance. Even though the focus was on supply constraints easing.
The Fed gameplan is to hope that the virus becomes less of an impact on supply chains, inflation eases, and they can begin to raise rates.
Little Monkey 