JUN 24, 2021
During its monetary policy meeting last Thursday, the Federal Reserve held the federal funds rate at the targetted range of 0-0.25% while keeping quantitative easing (QE) unchanged at $120 billion per month.
Inflation spike remains transitory.
The first focal point of this meeting is whether the Fed has toned down its view on inflation being transitory since the previous meeting. Specifically, the market would like to see the sentence “inflation has risen, largely reflecting transitory factors” been removed or modified in some manner in the interest rate statement. However, that sentence remains unchanged in the statement, indicating that the central bank is still downplaying the recent spike in inflation as transitory.
Although no change in the Fed’s view on inflation was made in the statement, the central bank did amend its view on the progress of the COVID-19 situation in the U.S. In the previous statement, it was stated that the “pandemic is causing tremendous human and economic hardship across the United States”; that sentence has been replaced by “progress on vaccinations has reduced the spread of COVID-19 in the United States” in the current release, indicating an optimistic outlook by the Fed on the vaccination programmes. Also, the central bank commented that “progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy” as opposed to its previous comment that “the ongoing public health crisis continues to weigh on the economy”.
The hawkish projection.
The main driver for the hawkish tone delivered by the Fed comes from the dot plot in the quarterly projection materials. Used as a tool to present the committee members’ projection on where the federal funds rate will be in the future, the latest dot plot indicated that more members are projecting interest rate to hike in 2023 than in the previous plot (June projection: 13 members vs. March projection: 7 members). This shows that many more members are leaning towards an earlier rate hike than the previously expected timeline of 2024, something that took the market by surprise as the general expectation is that the earliest rate hike will take place only in 2024. More members are also expecting a rate hike to take place in 2022 (June projection: 7 members vs. March projection: 4 members) although it may seem a bit early to do so.
Apart from the dot plot, the central bank has also revised its economic projections positively. The most prominent revision is the headline PCE inflation with an upward revision from 2.4% to 3.4% for 2021, 2.0% to 2.1% for 2022 and 2.1% to 2.2% for 2023. From the forecast, it is clear that the Fed is still expecting the recent rise in inflation to be transitory, projecting annual inflation to fall back to their targetted range of 2-3% after this year. Bear in mind that the main drivers of recent inflation, oil and used vehicles, are expected to last only for a short period. The rise in oil prices that drove up inflation back in quarter one has already stagnated while the rise in prices of used vehicles in the past two months are expected to decline once manufacturing plants for vehicles resume production. Another reason why the central bank has no problem with the rising inflation is because of the average inflation targetting policy that they adopted last year.
Projection for unemployment rate remains the same for 2021 and 2023 while a slight downward revision was made from 3.9% to 3.8% for 2022. It is also worth noting that total employment is still below the pre-pandemic level by around 7 million jobs. Finally, economic growth (GDP) was revised upwards from 6.5% to 7.0% for 2021, while holding unchanged for 2022 and a revision from 2.2% to 2.4% for 2023.
What about QE tapering?
With all the optimistic outlook and hawkish projections coming from the Fed, the next question that follows will be when will QE tapering be carried out. To the disappointment of many, there was no mentioning on that. However, Fed Chairman Jerome Powell assured the market that the topic of QE tapering was being discussed during the two-day meeting when he told a journalist during the press conference that this was a “talking about talking about” meeting.
Moving forward, it will be crucial to pay attention to any mentioning of the timeline of QE tapering whenever the Fed and its members make any public appearances. With rate hike expectation being brought forward to an earlier timeline, it will not come as a surprise if the central bank were to make any formal announcements on tapering this year and start taking action at the start of next year.
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