The Federal Reserve announced no major policy changes but did unveil its new forward guidance at the September Federal Open Market Committee (FOMC) meeting, as expected. The projections and the tone of the statement sent a dovish message, signalling that rates will stay near zero through 2023 – amid expectations that inflation will remain below target until then, as the economy takes time to return to its previous strength.
While the Fed acknowledged the better-than-expected outlook for the economy relative to that back in June, the language in its statement continued to emphasise the uncertainty around the virus trajectory and associated risks to the outlook.
The statement was adjusted to reflect the move towards the average inflation targeting framework last month, though no guidance was provided as to what a moderate overshoot of the 2 per cent inflation target means and how long the “for some time” that the Fed will allow price rises to run above target would be.
To reinforce the message from the new framework, in the press conference, Fed chairman Powell emphasised the Fed’s strong commitment to the inflation overshoot. He also made it clear that when assessing labour market conditions and inflationary dynamics, the Fed will use broad judgement, not a rule, by looking at a number of different indicators as it aims for maximum employment.
Since the last meeting, the economy has shown strong evidence of its rebound, with continued upside surprises in the labour market and virus cases on a downward trajectory. Financial conditions have eased further, and are now at even more accommodating levels than before Covid. This backdrop induced little urgency to act decisively at this month’s meeting given the recent framework shift.
However, it is clear from today’s message that the FOMC remains concerned about the outlook due to continued uncertainty about the virus trajectory. Moreover, in the press conference, Powell noted that the Fed’s forecasts assume some additional fiscal stimulus from Congress. However, with the probability of stimulus before the election decreasing, this is another significant concern for the Fed in the months ahead. Other factors such as the election itself, weak global recovery and trade tensions could complicate the recovery path.
Looking ahead, we expect the Fed to be on standby, ready for action at any time, should the economic outlook – or indeed market functioning – show any signs of deterioration. In case of no major emergencies, the Fed is likely to start transitioning from crisis-fighting policies towards a more traditional quantitative easing programme to support economic recovery, which it seems to be signalling already. This would involve adjusting the composition of purchases towards longer maturities in one of the upcoming meetings to further support financial conditions at extremely easy levels and help the flow of credit to the household and corporate sectors.
Published by Anna Stupnytska, Global Macro Economist, Fidelity