Fed underlines 2020 interest rate promise

Fed chairman Jerome Powell made a pledge on June 10, 2020. He said the bank is not considering rate hikes. "We're not even thinking about when we're going to start thinking about rate hikes." 

Those were words the financial markets were eager to hear. Everyone remembered the fall and winter of 2018 very well. Stocks fell sharply at the time as the market realized that the Fed really meant it when it deliberated on interest rates. It was built 2019 or 3 more times in 4. 

In recent weeks, there has been some nervousness about that June 10 promise. An important reason for this is the Fed itself. In December, Powell said he expected a weaker recovery in the first half of the year. But he is hopeful about the second half due to the arrival of the corona vaccines.

At the first press conference of 2021, Powell had to find a middle ground between keeping the glass half full (it would be weird if he suddenly felt less hopeful now than a few weeks ago) and taking that nervousness away. He succeeded

Unchanged course
He reiterated that the economic outlook for the second half of the year is good, but hastened to say that this does not mean that the Fed will change its monetary stance. This will only be discussed when inflation rises structurally slightly above 2 percent on an annual basis and the target of maximum employment has been achieved. 

The latter will be the case when the unemployment rate is around 4 percent... or so we thought! Powell added a not insignificant element this week by saying that the bank will not only look at the unemployment rate to determine whether maximum employment has been reached, but also, for example, the unemployment rate per population group. So when unemployment in the US falls to about 4 percent, that does not automatically mean that maximum employment has been reached. “The economy is a long way from employment and inflation targets and it will most likely take quite some time to make significant gains in those areas,” Powell said. In other words: for the time being, we will not change the course we have chosen. 

Learned from last time
Talking about less accommodative monetary policy and focusing on an exit from current policy is premature, the Fed chief said. The second variant for: for the time being, we will not change the course we have chosen. He added that the Fed has learned from last time. That 'last time' is the fall of 2018. Knowing that prices then fell sharply and financial stability was at risk, that lesson can be summed up as: don't do it again. 

The third variant for 'we will not change the course we are taking for the time being' was heard when Powell said that 'the link between low interest rates and prices in the financial markets is probably not as strong as people think'. That's an important note because Powell is essentially saying that even if stock prices were too high, it wouldn't be because of Fed policy. The bank can therefore continue without fearing that its policy will lead to a bubble. 

Not only did the Fed make it clear that the promise - that it won't even think about when it starts thinking about rate hikes - is still in effect. Powell also hinted that the Fed could ease monetary policy further, so cut interest rates further and/or buy more assets on the exchanges. "If employment and inflation don't move quickly enough to the levels we're aiming for, then we can signal that we're going to loosen up the policy even more." 

The Fed may be forced to think about rate hikes after all if inflation were to rise in the near future. Recovery, that's what could in theory throw a spanner in the works. In practice not, Powell was clear about that. Inflation will rise in the coming months due to a statistical effect (prices are compared to a much lower base 12 months ago). That is a temporary effect, the Fed captain said. And if prices rise later in the year when the economy gets going, as the Fed expects, that still won't be a reason for the bank to start thinking about rate hikes. We will also regard that as a temporary phenomenon, according to Powell.

Higher inflation welcome
The Fed would welcome higher inflation, not fear it. "We know what to do if inflation gets too high. It is much more difficult to deal with inflation that is too low," he said. In case it has not been clear until then: the promise of June 10, 2020 applies without prejudice. Whatever happens, I'd almost say.

Edin Mujagic

Edin Mujagić is an economist and manager at Beleggingsfonds Hoofbosch. He focuses on global central banks, and in his blogs he writes mainly about developments in interest rates and inflation. He has also written several books.

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