Wall Street is still weighing the implications of the Federal Reserve’s most significant change in the way it thinks about monetary policy over the years.
In short, Fed President Jerome Powell in his mandate on Thursday emphasized the primacy of the labor market, even if it means inflation rises above an annual 2% target that the central bank has traditionally called a healthy, well Is considered a sign of a working economy. .
Powell’s new policy outline comes after an 18-month review by the Federal Open Market Committee of setting the interest rate and targeting 2% inflation marked a subtle twist that now allows for undershoots and overshoots that time out. With inflation will see an average of 2%.
Powell said in his webcast speech as part of the annual Jackson Hole Symposium on Thursday, “This change may appear subtle, but it reflects our view that a strong employment market can be maintained without the outbreak of inflation Could. ”
Indeed, the shift is a big deal, say experts, and not only because of decades of disregard for central-bank conservatives focused on the relationship between the labor market and price pressures, but because it expresses a policy that can be overcome by a policy As advocated by Stanford University economist John Taylor, who has adopted a mathematical approach to setting interest rates.
The Fed’s new approach may, instead, raise more questions than answers about implementation and importantly how it achieves inflation targets that have thus been elusive over the past decade.
“How comfortable is inflation with the Fed?” Friday’s research note asked Jefferies chief economist Anita Markowska.
“The FOMC was surprisingly ambiguous in relation to the framework’s own inflation, only stating that it would have to receive inflation of more than 2 percent for some time after a period of undershoot.” What does this mean in practical terms? We just don’t know, ”the economist wrote.
After Powell’s Jackson Hole speech, some Fed officials tried to allow the central bank’s target to reduce inflation before raising alarms.
“For me, it’s 2.5% or 3%, not so much a number,” Philadelphia Fed President Patrick Harker, a voting member of the FOMC, said in an interview Friday. “It’s whether it’s reaching 2%, creeping up to 2.5% or shooting 2.5%,” he said.
St. Louis Fed President James Bullard, who is not currently a voting FOMC member, said on Friday that inflation could remain around 2.5% “for a considerable time.”
Inflation plays an important role in Fed policy because very low inflation can lead to a weak overall economy, as it may encourage consumers, the main drivers of the US economy, to delay purchases, as well as lower prices. Can increase expectations, a potential vicious cycle. As the Fed has stated, “If inflation expectations fall, interest rates will also fall.”
And Federal Funds Rate: It makes it difficult for the Fed to use its main tool to lower interest rates for monetary policy. The Fed lowers its benchmark interest rate to stimulate economic activity and raises it to slow down.
It is worth noting that the Fed has raised interest rates nine times between 2015 and 2018.
However, at least 2009 price pressures are nowhere to be seen, with a 5-year forward inflation breakdown projected at 1.6%, on a 5-year basis. That measure of inflation calculates the expected pace of price rise over a period of five years that starts five years from now.
Experts said the lack of clarity on the specifics surrounding its changed policy could increase market uncertainty.
“When it comes to the shift in how the committee views its inflation objective, a lot was missed, and careful consideration suggests that the new approach may actually complicate the policy process in terms of both implementation and communication Is, “Robert Eisenbis, chief monetary economist, in a Friday note on Cumberland Advisors.
Eisenbis says the Fed did not immediately specify which inflation measure it would use. Traditionally, the central bank’s preferred inflation gauge is the PCE price index or personal-consumption expenditure price index, but the gauge commonly referred to on Wall Street is the CPI, or consumer-price index.
“Finally, the fact that the elephant in the room [Fed] Has pursued a 2% inflation target since 25 January 2012, but steadily reduced that level, ”Cumberland analysts wrote.
What is Outlook?
Brokers Pepperstone research analyst Chris Weston wrote, The Fed will now need to really explore this new change at FOMC meetings, because it is telling us what they are planning, but they are actually learning the market. Is required.
FS Investments chief US economist Lara Rahme says the implications of the Fed’s move cannot play out until the end of the COVID-19 crisis.
“The real issue for investors after the economic crisis will be the same that comes after this economic crisis.”
“Many expect the economy to continue its recovery over the coming year or two. It can happen even faster. A vaccine or more effective treatment can help suppress the epidemic, ”said FS Investments analysts.
“but [Thursday’s] The announcement clarifies that a return to stable, potential growth would mean the Fed would potentially drop rates where they are at zero, ”economists said.
The upcoming 15–16 policy meeting of the Fed may fill some blanks for market participants.
Implications for markets
So what does all this mean for financial markets?
This means that there is a rule for potentially lower interest rates, but without more guidance on how the Fed’s policy will go, market expectations for volatility may increase.
In the short term, the stock may continue to rise or at least be inclined to remain stable with the Fed and more clearly indicate no intention to raise interest rates.
“One of the few things that could knock the market was the Fed started raising rates… I don’t know if it is [policy shift] “I’m definitely going to lead the meltup, but it definitely lays a more secure foundation under the market,” Brad McMillan, chief investment officer at the Commonwealth Financial Network, told Marketwatch.
On Friday, the Dow Jones Industrial Average DJIA,
About 3% off its February. 12 record highs, while the S&P 500 SPX,
And Nasdaq Composite Index Comp,
Both ended in records.
“At the moment it is hard to wager against the equity market,” said David Donabedian, chief investment officer at CIBC Private Wealth Management, in an emailed comment.
Macmillan of the Commonwealth also said that growth stocks, which are particularly on a tear, are likely to continue to benefit in the short-term low interest rate regime. “Future cash flows will currently be of greater value to companies that can generate it,” he said.
“Companies with pricing power, such as commodity stocks, will benefit. Banks will ultimately enjoy a steep yield curve. Without pricing power and thus to feed on rising cost pressures, profit margins will be squeezed and this will not be a good thing, ”wrote Peter Bokover, chief investment officer at the Blakeley Advisory Group, in a Friday note.
“Cheap stocks, the so-called price side, are already inherent in low expectations, so they will be more immune. Interesting timing, ”he said.
Analysts at BofA Global Research, including Michelle Mayer, said they do not expect a comprehensive run-up to the US dollar DXY
After Powell’s statement.
Analysts wrote in Thursday’s report that “a broader USD rally may eventually include another bout of risk aversion, as USD shorts are typically concentrated in the less price-sensitive asset manager community.”
In theory, a prolonged run of low interest rates and high inflation should provide support for gold and silver prices, which have already created considerable safe-haven flows as investors reported the economic impact of coronoviruses on trading activity Is noted worldwide.
And silver SI00,
Somewhat seen as a hedge against uncertainty and rising inflation. A weakness in the US dollar, or at least a stable greenback, may also help discount prices for precious metals.