MNI REVIEW: Fed Seeking Overshoot May Hold Rates Into 2024

The Fed pledged Wednesday to keep interest rates near zero until the economy reaches full employment and inflation is poised to "moderately exceed 2% for some time," disappointing those seeking more action during the deepest recession since at least the 1930s and clarity about prices overshooting.

Updated quarterly economic projections show just four of 17 officials expected to lift rates in 2023, even as the FOMC boosted expectations for medium-term growth, employment and inflation.

The surprise move adding economic milestones to rates guidance comes weeks after the Fed changed its long-term framework, targeting inflation averaging 2% over time and shortfalls from full employment. Market reaction was muted with equities down 1% over the course of Fed Chair Jay Powell's press conference.

"Rates will remain highly accommodative until the economy is far along in its recovery and that should be a very powerful statement in supporting economic stability," Powell said. "This very strong, very powerful guidance shows both our confidence and our determination."

The Fed will continue to increase its securities holdings "at least at the current pace over coming months," it reaffirmed Wednesday, which has been USD80 billion of Treasuries and USD40 billion of MBS a month. "There are various ways and margins there we can adjust our tools going forward and we'll continue to monitor developments and we're prepared to adjust our plans as appropriate," Powell said.

OVERSHOOT PARAMETERS VAGUE

Powell defined maximum employment as a judgment call that includes "low unemployment, high labor force participation, wages" and a broad range of other factors.

But as to how much of an inflation overshoot and for how long is more vague. A moderate overshoot Powell explained was "not large" and "not very high above 2%."

"For a time" means "not permanently and not for a sustained period," he said.

"We're resisting the urge to try to create some sort of a rule or a formula here," Powell said. "We want to achieve inflation that averages 2% over time. And if we do that, inflation expectations will be right at 2% and that will help us achieve 2% inflation over time and avoid the situation where the central bank loses its ability to support the economy."

Two dissenters on the new forward guidance represented views from both more hawkish and more dovish factions on the FOMC. Dallas Fed President Robert Kaplan preferred to "retain greater policy flexibility" and Minneapolis Fed President Neel Kashkari wanted to maintain the current policy stance until "core inflation has reached 2% on a sustained basis."

INFLATION CRED

"The Fed missed the Great Recession, wrongly raised rates from 2015-2018 in the belief the U.S. was close to full employment when it wasn't. Now they have underestimated the economic consequences of the Great Pandemic on the labor market and assumed that unemployment will fall steadily through 2021 to an average of 5.5%. I suspect they will be for turning all too soon," Dartmouth College economist Danny Blanchflower told MNI.

The Fed's dot plot showed that even many FOMC members see some of their goals as long shots. Fewer than four policymakers expect headline PCE inflation to exceed 2% in the next three years, with the median projection at 2% in 2023. The median of FOMC policymakers shows unemployment falling to 4% in 2023, close to the median estimate of its longer-run value of 4.1%.

Powell also cited downside risk to the Fed's forecasts should no further fiscal stimulus be given. "More fiscal support is likely to be needed," he said. "If there isn't additional support, and there isn't a job for some of those people or from industries where it's going to be very hard to find new work then that will start to show up in economic activity."

In the earlier decision statement, the Fed also said "it would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals."