The Fed’s Powell Signals Improved Economic Outlook as Monetary Policy Remains Accommodative

On Wednesday of this week, a little more than a year after COVID-19 began to severely impact the American economy, the Federal Open Market Committee (FOMC) met again to address the state of monetary policy and the macroeconomy. During his press conference following the meeting, Federal Reserve Chairman Jay Powell offered encouraging words about the state of the economic recovery in response to fiscal measures, specifically applauding Congress for their unprecedented relief efforts over the past year.

Powell also gave a slight update on the status of the economy in his FOMC statement remarks, stating that “following a moderation in the pace of the recovery, indicators of economic activity and employment have turned up lately, although the sectors most adversely affected by the pandemic remain weak.” Although service sector performance in the tourism and hospitality industries remains predictably suppressed given the effects of the pandemic, Powell added that household spending on goods has risen notably since the start of 2021, and that 379,000 jobs were added in the month of February.

These comments come on the heels of the long-awaited $1.9 trillion COVID stimulus bill that was signed into law by President Joe Biden on March 11.  In addition to sending out $1,400 payments to individuals across the country, the bill aims to extend unemployment benefits to $300 per week, expand the child tax credit, and boost state capacity for vaccine distribution to ensure the majority of Americans can become vaccinated as soon as possible.  With the effects of this stimulus still to be measured, those numbers and others may signal faster and more robust improvement as time goes on and the share of Americans vaccinated continues to grow.

            However, although the macroeconomic outlook has continued to improve as a result of fiscal and monetary measures, Powell made sure to reiterate that the economy remains markedly below pre-pandemic levels, especially in terms of overall employment. As a result, the chairman stuck to a consistent theme, stating that the Fed will remain “committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.” In specific policy terms, this means that the FOMC will continue to attempt to achieve their average inflation target of 2 percent, keep the target range for the federal funds rate at 0 to ¼ of a percent, and further increase asset purchases in the form of Treasury securities and mortgage-backed securities, among other efforts.

In addition to this statement, the FOMC also released its Summary of Economic Projections (SEP) detailing committee participants’ past and present macroeconomic forecasts for inflation, unemployment, real GDP, and the federal funds rate. With another round of large-scale fiscal relief being sent out to struggling individuals and businesses in conjunction with an impending rise in vaccinations, there was building curiosity regarding how FOMC participants would forecast inflation as well as interest rates. In December of last year, the SEP exhibited forecasts of inflation below 2% all the way to 2023, with the vast majority of FOMC participants expecting interest rates to stay around zero until 2023 at the earliest.

However, after additional stimulus and the prospect of more vaccinations leading to quicker recovery, these past forecasts have changed. In fact, newer forecasts of core PCE inflation expect prices to rise 2.4% with more modest estimates of 2% and 2.1% inflation in 2022 and 2023 respectively. As such, a small number of FOMC participants have begun to revise their projections regarding the path of the federal funds rate over the next few years, as some have begun to expect rate hikes earlier than initially forecast in 2022 and 2023. This was also reflected in the market about a month ago when longer term Treasury bond yields began to soar and before the FOMC meeting on Wednesday when 10-year yields hit a new 14-month high, indicating rising inflation expectations and subsequent interest rate hikes in the future. These yield movements have become a recent cause for concern, as this trend has caused the stock market to exhibit major volatility in recent weeks, sending many investors into a frenzy.

As a result, Chairman Powell was asked to address these concerns about rising inflation and the prospect of higher interest rates during his press conference. In response, he firmly reiterated that no changes to Fed policy will occur until labor market conditions have made substantial progress toward the central bank’s objectives of maximum employment and stable prices. He also provided strong forward guidance about the central bank’s future policy moves, indicating that the Fed would give clear notice when they intend to begin raising rates and that they would give this notice well in advance to give the markets time to adjust.

Powell also addressed the higher outlying interest rate projections in the SEP, mentioning that more uncertainty will always bring different perspectives and that the SEP is not a committee forecast. When pressed about the possible inflationary pressures mounting in the market, Powell stressed that the higher 2021 projections were the result of low inflation months in 2020 being dropped out of their internal inflation calculations. What does this mean for the Fed’s commitment to their average inflation target? The chairman wouldn’t quantify what the Fed’s makeup policy might look like, but he implied that once the central bank actually achieved its 2% target, there might be a clearer answer.

Overall, despite sticking to a mostly uniform message regarding Fed pandemic policy, Powell made a much greater attempt to assuage future concerns of higher interest rates and problematic inflation. His message was clear; the Fed is still a long way away from their goals, and it remains extremely important to continue to ensure that financial conditions remain accommodative in order to help foster continued economic recovery. Additionally, Powell made sure to stress just how important fiscal policy has been in helping the Fed achieve this goal while preventing long-term damage to the economy. With predictions of real GDP growth rising to 6.5% 2021 (up from earlier projections of 4.2%), and with the unemployment rate projected to hit 3.5% by 2023, the monetary and fiscal coordination has seemingly had a large positive impact on the recovery. Hopefully increased vaccinations will help continue to push this trend, since levels of employment still linger far below pre-pandemic levels and families and individuals continue to struggle.

Image Credit: Federal Reserve