Will The Fed Unveil A New Monetary Policy Today?

If it’s broke, fix it. The Federal Reserve is expected to embrace that rule when Jerome Powell, chairman of the central bank, speaks later today and outlines a new plan on inflation targeting.

“The expectations are pretty high to get something meaningful on Thursday,” predicts Tom Graff, head of fixed income at Brown Advisory. “This is probably a historic speech.”    

By some accounts, Powell will deliver a policy plan that’s the book-end opposite of Paul Volcker’s focus when, as Fed chairman in 1979-1987, he pursued a hawkish inflation strategy that sharply raised interest rates.

“The main gist of the message is likely to point to a desire to overshoot inflation but to no specific policies for getting there,” advise Roberto Perli and Benson Durham of Cornerstone Macro in a research note to clients on Wednesday.   

Measured by the Fed’s 2% inflation target, pricing pressure has certainly been low recently. Before the pandemic, the annual pace of personal consumption expenditures (PCE) inflation – the central bank’s preferred index for inflation – was running in the mid-1% range. But that moderately below-target pace has fallen sharply since the coronavirus crisis reordered the economy. Core PCE, for example, rose just 0.9% in June vs. the year-earlier level – close to a 60-year low.

Powell is widely expected to discuss what’s known as average inflation targeting (AIT). Barron’s summarizes AIT as a policy “to let the economy run hot whenever possible to offset all the times when prices rise too slowly. In practice, that means an inflation target of something closer to 2.25% when the economy is doing OK.”

Although the Fed will likely eschew radical changes, at least for now, a formal embrace of AIT would be a recognition that the currency policy isn’t working. In the grand scheme of managing the economy these days, this revision is likely to be a modest adjustment relative to recent history. Nonetheless, taking a more aggressive approach, even on the margins, is hardly trivial for the world’s most important central bank. A key question is how the markets – the Treasury market, in particular – reacts?

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