At its meeting overnight, the Federal Reserve kept its fed funds interest rate unchanged at 0.00-0.25% and left its pace of quantitative easing at USD120 billion a month of bond buying.
The Fed was cautious on the very near-term outlook given winter virus waves, noting: ‘the pace of the recovery in economic activity and employment has moderated in recent months, with weakness concentrated in the sectors most adversely affected by the pandemic.’
The central bank’s concerns about the immediate outlook may have contributed to the sharp fall in US stocks overnight with the S&P 500 down -2.57%. But the Fed stressed it would keep monetary policy very loose to support the recovery and vaccinations would allow economic activity to return to more normal levels over time.
We thus see the Fed’s dovish stance continuing to support risk assets over the course of 2021.
First, the central bank is squarely focused on returning the economy to its twin goals of full employment and stable inflation. In his post-meeting press conference, Fed Chair Jay Powell rebuffed questions on the recent spikes in individual US firms’ share prices, noting: ‘I don’t want to comment on a particular company or day’s market activity.’
Second, Powell pushed back on fears the Fed would start slowing down its quantitative easing this year.
‘In terms of tapering, it’s just premature. We just created the guidance [on how long the central bank would keep printing money and buying bonds]. We said we wanted to see substantial further progress toward our goals.’
Third, Powell said the Fed expected inflation to return to its 2% target this year. But he warned it would only be a ‘transient’ rise caused by the base effects of last year’s weak inflation readings at the start of the pandemic falling out of the year-on-year change in consumer prices now.
Instead, Powell said the Fed wanted ‘inflation moderately above 2% for some time’ - to achieve its new strategy of inflation averaging 2% over the business cycle - before the central bank would consider raising interest rates.
This would make up for the prior years that the Fed has undershot its inflation target (see chart).
Last, Powell said it ‘appropriate’ that Congress was discussing further fiscal stimulus to support the recovery after the Biden administration proposed fresh aid worth USD1.9 trillion. But the Fed Chair reiterated very loose monetary policy would still be needed to boost the recovery.
The Fed’s meeting thus underscores our view that the central bank will keep supporting risk assets in 2021 while also undermining the safe-haven USD.
We expect the Fed will not start tapering its quantitative easing until 2022. We also do not see interest rates being raised until at least 2024 with inflation likely to remain below 2% for much of the next three years.
This article was first published by Bank of Singapore on January 28, 2021. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.
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