Higher Ground: Fed Keeps Rates Unchanged but Upgrades Outlook

Key Points

  • The FOMC kept rates and its balance sheet purchases unchanged, but upgraded its economic, employment and inflation outlooks.

  • A rising percentage of officials now expect earlier rate hikes; with four projecting the federal funds rate could be hiked as soon as next year.

  • Transient price shocks should be differentiated from inflation that meets the Fed’s goal.

Much to no one’s surprise, the Federal Open Market Committee (FOMC) of the Federal Reserve kept the federal funds rate in a range between zero and 0.25%, where it’s been for a year. In terms of its median projection, the FOMC continues to believe rates will stay near the zero bound at least through 2023; although it did upgrade the economic outlook amid the recent surge in Treasury yields and COVID vaccine-related optimism. The FOMC is leaving asset purchases unchanged at $120 billion per month ($80 billion of Treasuries and $40 billion of mortgage-backed securities), and repeated that this pace would be maintained until “substantial further progress” is made with regard to the Fed’s inflation and employment mandates.

There were limited changes in the March FOMC statement relative to December’s; but importantly, the economic outlook was upgraded. The key new statement: “Following a moderation in the pace of the recovery, indicators of economic activity and employment have turned up recently, although the sectors most adversely affected by the pandemic remain weak. Inflation continues to run below 2 percent.” There was no mention of virus or vaccine progress, nor did the statement address recent fiscal stimulus. Initial market reactions included a rally in U.S. stocks, a drop in the 10-year Treasury yield and a dip lower in the U.S. dollar. 

New SEP and dots plot

As the FOMC does at every March, June, September and December meeting, an update of the Summary of Economic Projections (SEP) was provided, with a detailed table shown below. Seven out of 18 FOMC officials are predicting higher short-term interest rates by the end of 2023 as compared to five out of 17 at the December meeting (i.e., a growing percentage who see an earlier start for rate hikes). Notably, four officials now expect a rate hike at some point next year. The new so-called “dots plot” shown below the table shows the spread of projections among the current 18 FOMC officials.

031721_dots plot031721_sep table

Source: Charles Schwab, Federal Reserve, as of 3/17/2021. Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are percent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. 1For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. 2Longer-run projections for core PCE inflation are not collected.

As seen in the table above, the FOMC also upgraded its forecasts for economic growth and job growth, with the median estimate for unemployment dropping to 4.5% by the end of this year; and 3.5% in 2023. Fed officials—including Chair Jerome Powell—have been highlighting alternate measures of employment given that most of the traditional headline figures around unemployment don’t accurately capture the millions of Americans who have dropped out of the labor force due to the pandemic. 

Real gross domestic product (GDP) is now expected to grow 6.5% this year; up from December’s projection of 4.2%. This year’s FOMC forecast is more optimistic than the 6.0% median forecast of economists surveyed by Bloomberg. In terms of inflation, FOMC officials expect a spike in the personal consumption expenditures (PCE) inflation index—which is the Fed’s preferred measure—to 2.4% this year; followed by an easing of price pressures to 2% in 2022. Core PCE, which excludes food and energy, is expected to hit 2.2% this year, followed by a drop to 2% next year.

Some highlights of Jerome Powell’s press conference

  • Powell reiterated that the Fed will “telegraph” its plans with regard to balance sheet tapering and will “continue asset purchases at this pace until we see substantial further progress—and that’s actual progress, not forecast progress.”
  • Powell deflected a question about the Fed’s Supplementary Leverage Ratio (SLR) bank capital adequacy exemption, which expires at the end of this month; saying “we’ll have something to announce on that in coming days.”
  • As referenced above, Powell referred to the headline unemployment rate as a “very insufficient statistic;” while also noting that elevated Black and Hispanic unemployment is “sad to see” given the rate was much lower pre-pandemic.
  • When asked about the recent move up in bond yields, Powell said he would be concerned if “disorderly conditions” were evident in markets, or if financial conditions became persistently tighter; but doesn’t believe higher yields are an imminent catalyst for either.
  • With regard to fiscal policy, Powell said he does believe it “will have really helped us to avoid” the worst of the longer-term economic scarring that could have come out of the pandemic.
  • Powell noted that the U.S. recovery is leading the global recovery; but also said that the key for longer-term prosperity will be a “healthy” focus on investment—including in people skills, plant and equipment, software, etc.
  • Powell said the Fed is a few weeks away from announcing a decision on whether to extend its restrictions on bank buybacks and dividends.
  • In terms of the expected jump in economic activity, Powell said “it’s all ahead of us” and that he expects it to remain strong “for some time.”
  • In terms of inflation, Powell expressed his view that the era of a tight connection between low unemployment and inflation is “long gone.”
  • Powell also addressed the “base effect” coming; with year-over-year inflation comparisons over the next couple of months to be skewed due to the economic shutdown at the same time last year; while also differentiating systemic inflation from “transient price bumps.

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