September Fed Meeting: The (Long) Wait For 2% Inflation Begins

Economists were focused on three facets of the U.S. Federal Reserve (the Fed)’s meeting today. Importantly, none of these three outcomes were particularly consequential for investors.

1. New forward guidance
Would the Fed clarify its forward guidance on interest rates following Powell’s announcement at the annual Jackson Hole, Wyoming, economic symposium about the transition to a new average inflation targeting (AIT) framework? 

As a reminder, AIT is basically a commitment to keep interest rates lower for longer, allowing inflation to overshoot the 2% objective for a time to compensate for undershoots that normally occur during recessions and the early years of an economic recovery. The Fed did enhance its forward guidance today, committing to keep interest rates at zero until the U.S. economy reaches full employment, and “inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” 

Put differently, the Fed has pinned liftoff to an economic outcome, namely that inflation must hit its 2% objective and be expected to exceed it for some time. No major surprises here, although some economists did not think the Fed would be able to agree on this new language until the November meeting.

2. Interest rate forecasts for 2023
Would the Fed show any rate hikes in its updated forecasts, which now include the central bank’s expectations for 2023 for the first time? 

13 out of the 17 Federal Open Market Committee (FOMC) participants penciled the federal funds rate to remain at the zero bound through the end of 2023 under their baseline outlook. While this is a dovish statement on the surface, it will not have been very surprising to professional investors given fixed income markets were already priced to the floor with only one quarter-point rate hike expected from the Fed over the next five years (chart). This pricing did not move much in the 30 minutes around the announcement.

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