When Doves Fly – September 21, 2020
There are two terms that are used to describe sentiment from Federal Reserve officials – dovish and hawkish. Dovish describes a Fed that is less worried about inflation and more worried about jobs. Doves are less likely to raise interest rates. Hawkishness is the mirror image.
Through the Fed’s statement and press conference last week, Fed Chief Jerome Powell tried to clarify the Fed’s new policy and longer-run strategy, which was unveiled at the end of August.
The new framework suggests rates will remain low for a long time, which could have significant implications for savers, borrowers, and investors.
The Fed’s dual mandate of full employment and price stability is set by Congress. The Fed has the discretion over how it defines its mandate and the policy it utilizes to meet the objectives.
The Fed does not provide a numeric goal for full employment. It defines price stability as 2% inflation per year. Based on the Consumer Price Index and the PCE Price Index, inflation undershot the goal during much of the last decade.
In the past, the Fed took aim at getting inflation to 2%. In the past, it would preemptively raise rates, as we saw between 2015 and 2018.
Going forward, the Fed “will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time (my emphasis),” per its statement. In other words, the Fed wants to average 2% over a longer period but is ok with overshooting for a little while.
It expects to keep the fed funds rate near zero until we’re at (1) maximum employment, “(2) inflation has risen to 2%, and (3) is on track to moderately exceed 2% for some time.”
It is a 3-part test. It sounds confusing, and it raises plenty of questions.
One that came up in the press conference: What does ‘moderate’ and ‘some time’ mean? Powell responded that moderate “means not large. It means not very high above 2%. It means moderate. I think that’s a fairly well-understood word.”
He said that ‘some time’ could be defined as “not permanently or for a sustained period.”
There are no numeric triggers. It gives the Fed wiggle room as it implements policy.
And, there’s one more thing. If risks emerge that could impede the ability to reach its goals, such as risks to financial stability, rates could change.
Of course, the Fed could fail to meet its inflation goal, or it could meet it very quickly.
Powell recognized what most of us have seen. Food prices are up. But that may be temporary. Data from the Consumer Price Index suggest the rise in food prices is abating.
Good news
In the Economic Projections from the Federal Reserve, the Fed lowered its year-end forecast for the unemployment rate from 9.3% to 7.6% (June vs September forecast). It raised its 2019 GDP forecast from a 6.5% decline to a 3.7% decline.
It projects no change in the fed funds rate through the end of 2023.
In today’s environment, economic forecasts are extremely problematic. Even in the best of times, forecasts can miss the mark. But the stronger-than expected recovery in Q3 forced Fed officials to revise their estimates. We may see further revisions down the road.
Bottom line—It’s a very dovish Fed that wants to use all its tools to support the economy and get unemployment back down. It’s willing to tolerate a little bit of inflation (if it were to occur) to hit its goal of full unemployment as quickly as possible.
One final remark: The thought we might have a jobless rate below 8% by year-end seemed improbable at the height of the crisis. It may turn out to be reality.
Created 2020-09-21 15:21:17