Work in Progress: Fed Stands Pat

Key Points

  • The Fed made no changes to its interest rate or balance sheet policies; but some of the language in its statement was tweaked, reflecting recent hotter inflation data.

  • Underscoring a bit of a hawkish tilt, the FOMC—in its dots plot—signaled they now expect two interest rate increases by the end of 2023.

  • Despite continued progress in the labor market and an increasing pace of inflation, Chairman Jerome Powell reiterated that the Fed will be transparent in signaling when a tapering in asset purchases is to come.

As expected, in a unanimous vote, the Federal Open Market Committee (FOMC) of the Federal Reserve (Fed) kept the fed funds rate unchanged in its range of 0-0.25%. The accompanying FOMC statement had a few changes relative to June; including a reference to economic activity and employment which “have continued to strengthen … but not fully recovered.” The statement was also more explicit with regard to the Fed’s goals of maximum employment and price stability: “Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings.” Notably absent in that new sentence was “substantial” in front of “progress.”

The statement repeated language that inflation had run persistently below the Fed’s long-run 2% goal. The third consecutive “hot” inflation report came between the June and July meetings; and the repeat of the inflation language suggests there were not many new tidbits in the Committee’s inflation conversation. Notably absent from the statement was any reference to COVID-19’s Delta variant. However, the statement did drop a line from June’s statement about vaccines having “reduced the spread of COVID-19 in the United States”—perhaps a subtle nod to concerns about Delta.

The FOMC also pledged to continue asset purchases at $120 billion per month until the aforementioned “further progress” has been made. Since September of 2020, the Fed has been buying $80 billion of Treasuries and $40 billion of mortgage-backed securities per month. Fed Chair Jerome Powell has said the Fed would begin talking about when and how to taper its bond purchases at this week’s meeting; promising ample advance notice relative to the tapering start point. That said there is building frustration among Fed watchers/investors that there has been nothing quantified by the Fed as to how they are defining “substantial further progress.” In fact, the very first question asked at the post-FOMC press conference was specifically about how it’s being defined (more on the press conference below).

In a separate statement, the Fed also announced that it established two standing repurchase (repo) agreement facilities and that “these facilities will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning.” The foreign repo facility essentially makes permanent a temporary program set up by the Fed during the most stressful stage of the pandemic—when foreign central banks were selling Treasuries for dollar cash. That repo facility allows global central banks to access dollar liquidity quickly from the Fed without having to resort to selling securities.

Powell presser

In his opening remarks of the post-FOMC press conference (note: our comments cover the first half hour), Jerome Powell mentioned that the current 5.9% unemployment rate “understates” the weakness in the labor market; while also highlighting supply constraints within certain industries—not least being autos. Powell also discussed household spending, noting that it’s “rising at an especially rapid pace” recently. In response to the aforementioned initial question on the definition of “substantial progress,” Powell essentially stuck to his prior “script,” and said “maximum employment” is difficult to estimate and that there are myriad indicators the Fed is monitoring.

In response to a question about when the Fed will actually begin raising rates, Powell answered that “we’re clearly a ways away from raising interest rates” and that it’s not something “on our radar screen” at present. With regard to the virus, Powell mentioned that with “successive waves of COVID over the past year and some months now, there has tended to be less in the way of economic implications with each wave.”

Powell has been vocal about the Fed’s sub-goal of not only helping bring the unemployment rate down, but having labor market improvement “spread broadly in the economy.” In a response to a question about global growth divergences, Powell said that an important feature of the recovery so far is how “uneven” it is, specifically citing countries’ varied access to vaccines.

Inflation remains a hot topic; so it was surprising that it wasn’t a subject of questions right out of the block. Once asked about his thoughts, Powell did note that “in the near term, the risks to inflation are probably to the upside.” However, he also expressed the view that the “bulk of the overshoot” in inflation can be explained by factors explicitly associated with the reopening of the economy.

In response to a question about the significant drop in the 10-year yield since the end of March (from 1.74% to the recent low of 1.19%), Powell said there was not a “single explanation.” He does not see anything yet that calls into question the Fed’s “framework” when it comes to the message from lower yields. He also said that the Fed’s new framework is well understood; but that the “real test” will come when the Fed begins raising rates.

When pressed for more thoughts on the labor market, Powell said it’s unusual to have record job openings with still-high unemployment. Saying further progress “may take some time,” Powell also suggested that many people are still job hunting and that “people want to work.”

In sum

We expect that there may be more detailed taper talk at next month’s Jackson Hole Fed confab; with the most likely start point of tapering in December. Based on that timeline, the initial rate hike would not likely happen until late-2022, since it would take six-to-seven months to taper purchases at the pace we expect. That said, the data will ultimately determine the timing and speed of tightening. In terms of the Fed’s establishment of standing repo facilities, we believe it is not a major issue for individual investors, but it should alleviate some of the concerns in the market among institutional investors.

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