The Fed’s convoluted message on keeping rates low
Following the official unveiling of its ‘flexible average inflation targeting’ strategy in August, the Fed fine-tuned its guidance on future rate hikes on 16 September. The Fed now has a three-point check list for raising rates: inflation needs to be at least 2%, “on track to moderately exceed 2% for some time”, and employment should be at its “maximum”. Yet the new guidance was no game changer as the Fed had already explained at length its desire to keep rates low for several years. In general, we found chairman Jerome Powell’s clarification on the Fed’s new approach to inflation targeting somewhat perplexed. In particular, we feel it is not as revolutionary as it could have been and is actually a mix of old and new policies.
The Fed’s ‘low-for-long’ stance was reflected in new projections, which showed rates remaining at zero into late 2023. The projections also showed expectations that PCE inflation will move up very slowly—only reaching 2% by late 2023.
The Fed left its monthly asset purchases at USD120 bn per month, and chairman Jerome Powell struggled to explain conditions for any change in that amount, even though he acknowledged QE was being used for monetary-policy purposes now, not just to foster market liquidity. In line with longstanding Fed thinking dating back to the Ben Bernanke’s years, Powell once again rejected the notion that QE is fuelling an asset-price bubble rather than consumer price inflation. The Fed chairman was prudent about the US macro outlook, saying the Fed hoped a fiscal package will pass in Congress to help support the recovery.
While Powell said the new guidance on rates is “powerful”, we are slightly less enthusiastic, believing the Fed will come under increasing pressure to use the QE lever more forcefully, especially since the US recovery is at risk of stalling due to ongoing social-distancing needs. We therefore continue to expect a step-up in asset purchases in the fourth quarter. More QE could come as soon as the next meeting on 4-5 November, right after Election Day, if Congress wavers about a new relief package for households.
The Fed remains reluctant to use negative rates and Powell gave no hint that opposition to negative rates had lessened within its ranks. Indeed, we think further increasing its balance sheet will be preferred to negative rates in the coming years.
More generally, we continue to believe we are in a ‘soft’ Modern Monetary Theory (MMT) regime. As US monetary policy continues to push on a string, disinflation will remain an issue— partly owing to structural reasons like technology, demographics and globalisation. However, a move to a more undiluted form of MMT with direct Fed subsidising of government and household budgets (via their bank accounts) would be a total inflation game changer.
Read full report here