Excerpts from WSJ 4/28/21:
The Federal Reserve held its key interest rate near zero and said it plans to continue supporting the economic recovery, while acknowledging recent progress in growth and employment.
Fed officials voted unanimously Wednesday to maintain the central bank’s policies, aimed at holding down borrowing costs, until the economy heals further from the effects of the Covid-19 pandemic.
“Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened,” the Fed said in a statement released after the conclusion of its two-day policy meeting. “The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors.”
Fed Chairman Jerome Powell said at a news conference Wednesday that the recovery has advanced “more quickly than generally expected,” while adding that it “remains uneven and far from complete.”
The Fed has held overnight interest rates near zero since March 2020, when the Covid-19 pandemic and related restrictions delivered a severe blow to the economy. Since June, the central bank has also been purchasing at least $80 billion of Treasury bonds and at least $40 billion of mortgage-backed securities a month to hold down longer-term borrowing costs for consumers and businesses.
Fed officials reiterated Wednesday that they will hold rates steady until the labor market is back to full strength and inflation has reached the central bank’s goal of averaging 2%. Most indicated last month that they expect to leave rates near zero through 2023.
They also repeated Wednesday that they want to see the economy make “substantial further progress” toward maximum employment and 2% average inflation before starting to reduce the pace of bond purchases. Mr. Powell has said that process would likely begin well before the Fed starts to raise rates.
He said Wednesday “it’s not time yet” for officials to start discussing a pullback in the Fed’s asset purchases.
“Economic activity and hiring have just recently picked up after slowing over the winter,” Mr. Powell said. “And it will take some time before we see substantial further progress.”
The yield on the 10-year Treasury note edged lower after Mr. Powell’s remarks, closing at 1.621%, down from around 1.64%. Yields rise when bond prices fall.
“The Fed has decided it is more willing to risk a bit of overheating than derail a burgeoning boom,” said Grant Thornton Chief Economist Diane Swonk, in a note to clients.
The economy has picked up steam in recent months as vaccination rates have risen, business restrictions have eased and the latest round of federal stimulus money has fueled spending. Consumer confidence rose in April to the highest level in 14 months, the Conference Board said Tuesday.
Inflation has also accelerated, as the Fed noted. The Labor Department’s consumer-price index jumped 2.6% in the year ended in March, compared with a 1.7% rise in February from a year earlier. The Fed’s 2% inflation goal is linked to a different measure, the personal-consumption expenditures index, which tends to run a bit below the CPI.
The CPI pickup stemmed largely from a combination of higher energy prices and comparisons with price levels a year earlier, when they fell sharply with the onset of the pandemic, a measurement issue known as “base effects.” But some of the price increases reflected rising demand for many goods and services as the economy revived, analysts said.
“We know that the base effects will disappear in a few months,” Mr. Powell said. While increased demand for goods and services is harder to predict, he said, “We think of them as not calling for a change in monetary policy, since they’re temporary and expected to resolve themselves.”
Fed officials expect inflation to rise above 2% this year and recede to that level by the end of next year. They tend to look past volatile food and energy prices and have indicated a willingness to tolerate inflation moderately above 2% as long as it Is due to temporary factors.
As more evidence of a speedy economic recovery emerges, officials will likely begin outlining when and how they expect to ratchet down the Fed’s bond purchases. Mr. Powell has said he wants to give plenty of advance warning ahead of such a shift.
His challenge will be to communicate the pivot while minimizing disruptions to financial markets.
The last time the Fed signaled a reduction in asset purchases, in 2013, it sparked a bond-market selloff known as the “taper tantrum.” An ensuing spike in Treasury yields jolted Fed officials who worried they might undermine the economy’s recovery from the 2007-09 recession.
In contrast to that time period, the economy is now widely expected to recover faster. Yields on U.S. government bonds and certain derivatives suggest investors believe the Fed will be able to start raising rates by 2023, sooner than most central-bank officials have indicated.
Continued increases in inflation could put the Fed in an uncomfortable position this summer, some economists say, if price pressures prompt market participants to push up borrowing costs sooner than the central bank anticipates. If the Fed starts tightening policy to combat inflation, it could drive interest rates even higher—potentially slowing the recovery. But if it doesn’t act in response to higher inflation, investors might worry it has become complacent.
Mr. Powell’s strategy is to convince market participants that the Fed will remain patient as long as inflation doesn’t rise too much for too long, but will tighten policy if needed to keep price pressures under control.
“We know that our job is to achieve 2% inflation over time,” he said Wednesday. “We’re committed to that, and will use our tools to do that.”
The big event this week is FOMC meeting which starts on Tuesday, and the announcement scheduled for 2 PM EST on Wednesday. In preparation, you may want to read this informative piece from WSJ.
The process of ending the Fed’s giant bond-buying program, and subsequently raising interest rates, will take years unless inflation unexpectedly surges. Its first step down that road will be to start talking about it in the coming months or weeks—Chairman Jerome Powell’s next big test with financial markets.
Officials will begin by debating how and when to scale back, or taper, the $120 billion-plus of Treasury and mortgage bonds the Fed has been buying each month since last June to hold down long-term borrowing costs.
That conversation hasn’t yet kicked off, according to public comments from central bankers and minutes from their March 16-17 policy meeting. The Fed said in a postmeeting statement that the U.S. labor market and inflation would have to make “substantial further progress” before it begins to reduce its bond program. Asked at a press conference whether it was time to start talking about talking about reducing bond purchases, Chairman Jerome Powell said, “Not yet.”
On April 14, Mr. Powell took a small and subtle but important step by establishing parameters for the coming discussion, more clearly defining his goal. The Fed will be measuring the economy’s progress “from last December, when we [first] announced that guidance,” rather than from March, when policy makers reiterated it, he said. That means with each indicator of improvement, there is less ground to make up.
This is delicate business for a central banker. The last time the Fed started telegraphing a reduction in its asset purchases, in 2013, it sparked a bond-market selloff known as the “taper tantrum.” Mr. Powell, then part of a small cohort of governors pushing to scale back the program, was in the middle of the discussion. Yields on 10-year Treasury notes, which directly affect long-term borrowing costs for consumers and businesses, jumped half a percentage point in just one month, rattling Fed officials who worried they might undermine the recovery they had been trying to nurture.
Jeremy Stein, who served with Mr. Powell on the Fed’s board of governors during the 2013 unpleasantries, said a lesson he drew from the episode is that there are limits to the central bank’s ability to calm markets amid a shift to tighter policy.
Mr. Powell has said he hopes to minimize disruptions this time by giving the market plenty of notice ahead of any changes to its bond-buying plans.
The U.S. labor market remains 8.4 million jobs short of its pre-pandemic level, a figure Mr. Powell often references to illustrate the distance remaining to a full recovery. In welcoming the 916,000 jobs created in March, he said the Fed wants to see “a string of months like that so we can really begin to show progress toward our goals.”
Since December, when the Fed set the guidelines for rewinding bond purchases, payrolls have increased by 1.62 million. That is certainly progress, though it doesn’t seem to meet the Fed’s mark of substantial. The jobless rate has fallen from 6.7% to 6% but remains well above the 3.5% level reached before the pandemic.
Pulling back easy money this time could look different than the slow and carefully staged process that took place last time. After the 2007-09 recession Washington officials focused on reducing budget deficits, which seemed to hold back growth, and inflation was tame. This time, trillions of dollars of fiscal stimulus are coursing through households, businesses and local governments, charging up growth. Economists expect inflation to reach 3% by midyear due to temporary factors and then retreat.
Primary dealers surveyed by the New York Fed in March expected the central bank to begin cutting bond purchases in the first quarter of 2022 and finish by the end of next year. The first increase in interest rates, currently pegged near zero, would likely come some time after. Fed officials expect to leave rates unchanged through 2023, according to their own projections.