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

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Market pricing on interest rates

Source: Thomson Reuters Datastream, Russell Investments calculations as of 11:30 a.m. Pacific time on September 16, 2020.

3. Asset purchases
Would the Fed change the average maturity of its asset purchases to focus more on longer-term bonds? 

The Federal Reserve’s quantitative easing (QE) program to-date has bought Treasury securities across the Treasury curve. There is a view in the market—with short-term rates already glued to the floor—that the Fed could get more bang for the buck in terms of easing financial conditions by purchasing more duration from the market. Chair Jerome Powell did not go there today. 

If we were to try to unpack why the FOMC did not do so, it is probably because they see too much uncertainty in the economic outlook from the virus to be that precise OR that they view the prevailing level of long-term rates as already being sufficiently accommodative.

Rate and market outlook

The path forward largely hinges on the medium-term outlook for U.S. inflation. As we’ve written about, inflationary pressures are normally a consequence of an economy having more aggregate demand for goods and services than its productive capacity can handle. Given COVID-19 drove a recession and a shortfall in aggregate demand, we do not see upside risks to inflation as being a major concern for at least the next one to two years.

Put differently, there is still a hole for the economy to climb out of before the output gap (economist lingo) closes. In our most bullish scenario for the economy (reflecting on the historic levels of fiscal stimulus, the natural disaster nature of the COVID-19 shock, and the better-than-expected economic news in recent months), we see rate hikes as being possible in late 2022. However, our central tendency is similar to the Fed’s, with it being much more likely that the central bank remains on hold through 2023 before inflationary pressures start showing an overshoot.

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Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

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