Interpreting The FOMC Report of June 2021
Fed estimates a rise in inflation, and its likely interest rates rise in 2023
The latest FOMC (federal open market committee) statement was on 15–16th June 2021. It is the policy-setting body in the US Federal Reserve system. They expected the overall GDP growth to reach 7% in 2021, and for 2022, 2023 projection remained unchanged. They also projected that the federal fund rate would rise from 0.1% to an average of 0.6% by 2023. It’s something they were not able to forecast earlier in the year.
The average projection for federal funds rate displays how the committee sentiment changes with time. To approach a change in interest rate, few members should believe that the policy needs change. That affects the interest rate projected but not the median rate. With time as the members become in favour of the change, the average projected rate changes, and only when a majority are in support will the median change.
Shifts in the estimated interest rate are to be given warning beforehand for future changes in policies.
In their statement, they mentioned remaining committed to promoting the stability of prices and jobs. They noted an increase in inflation had been attributed mainly due to transitory factors.
The projections raised by the members for PCE (personal consumption expenditure) inflation in 2021 rose to 3.4% and will drop to 2.1% in 2022. They will remain unchanged for 2023.
The projections indicate that the current rise of inflation is short-term, and the factors are linked to the economy reopening.
Vaccinations against COVID-19 are still going on in the USA, bringing back confidence in the sectors adversely affected by the pandemic.
The economic progress will depend on the course of the virus, although the vaccine will help reduce the burden put on public health and the economy. Even though the doctors feel there is a long way to go, the population vaccinated is barely halfway for ages above twelve.
They also stated that they should maintain a considerate stance on monetary policy as long as inflation averages 2% over time.
The federal fund target rate will remain unchanged between 0% to 0.25 %. Also, the federal reserve will continue to increase the treasury securities holding by $80 billion and mortgage-backed securities by $40 billion monthly. It will continue until the committee’s goals of employment and price stability attain.
The banks had an increase in deposits since the Fed was overnight printing money while lending it at the lowest rates. In raising the interest rate, the banks pay on the reserves by five basis points. That should move the interest rate closer to the middle of its range.
The Fed also announced that it would extend its temporary dollar liquidity swap lines with nine other central banks through to 31st December 2021. Initially, they were to expire in September 2021.
The asset purchases will help the market function and accommodate financial and credit flow to businesses and households.
Jerome Powell, the Fed chairperson, told reporters that the committee had started to discuss FOMC options of ending the bond-buying program. From the new 2023 estimated timing of the first-rate hike.
He said that the FOMC would announce the first reduction of the bond purchase program as early as September 2021. With the hawkish changes to FOMC participants’ path, expectations had come despite little change in 2023 forecasts in the unemployment rate and inflation. It suggested a reduction in tolerance of inflation than earlier thought.
The Fed preferred plan and timing for tapering should be more clearer in the upcoming meetings. After the meeting on 16th June, if the Fed tapers the pace of monthly purchases, it’s likely to follow a pre-planned path that takes two to three quarters.
The committee seems to focus more on modalities of tapering, like what economic conditions tapering could start and how fast cutting bond purchasing should be, in turn, warning market participants.
The investment implications from the statement by the chairman on the economic projections are a reflection of growth, which will come from higher inflation than targeted. The Fed may be anxious, and if the labour markets rebound in the months ahead with inflation still elevated, they may be put in a situation and may pull forward with the tapering cycle.
Chair Powell stated that the committee should provide a notice of any tapering decision in advance. That would come as a form of guidance that states, the FOMC will be expected to meet further substantial progress.
In the conference, Powell also signaled that the economy was recovering fast than it had previously estimated. Reaching the standard of further progress was necessary before it became appropriate to strengthen the monetary policies. It was still way off, and participants expected progress to continue. The improvement in the labour market was rapid, and he expected a tight return to the labour market.
The median dot plot was pointing to interest rates increasing in 2023. He noted that the dot plots were not committee predictions but individual estimates. The FOMC had not discussed whether a lift-off would be suitable because it would be untimely.
In general, he pushed back against any idea that the Fed had any plans to increase interest rates.
Market response
The markets saw the Fed as hawkish; this sent the asset prices down. US equities sold off with indexes of DOW JONES (0.77%), S&P 500 (0.54%), and NASDAQ (0.24%) declined respectively.
The dollar index rose 0.7% to 91.1 of which tracks the greenback against six other significant currencies. We also saw US treasury yields rise.
The five-year yield surged 12bp, and the ten-year surged 8bp to 1.58%.
In Europe, the markets changed the following day. The government bond yields rose slightly.
The risk-sensitive currencies had a reversal after the announcement. The sterling dropped by 0.49%, the New Zealand dollar down by 0.98%, and the Australian dollar rose by 0.95%.
In the Asian markets, the dollar gained against the Japanese Yen by 0.39%.
In the crypto market, bitcoin, the largest cryptocurrency, fell by 4.34%.
