Sure of the Recovery, Unsure About Rates

Sure of the Recovery, Unsure About Rates  While talk of tightening and tapering grabbed the market’s attention, Federal Reserve policy makers also showed how bullish they are on the economy. That was seen in the opening of the statement from the Federal Open Market Committee. For 14 months, its policy statement had featured this sentence: “The Covid-19 pandemic is causing tremendous human and economic hardship across the United States and around the world.” That sentence is now gone. Instead, today’s statement, following a two-day meeting of the FOMC, says: “Progress on vaccinations has reduced the spread of Covid-19 in the United States. Amid this progress and strong policy support, indicators of economic activity and employment have strengthened.” As a result, Fed officials see a booming recovery, with economic growth at a 7% annual rate by the fourth quarter. They also expect inflationary pressures to start to abate. At the same time, Matthew Klein wrote on Barrons.com, they “disagree about what they need to do to ensure this high-growth/moderate-inflation scenario comes to pass.” That disagreement is evident in that while the latest economic projections are nearly unchanged from those made in March, most Fed policy makers now think higher interest rates will be needed sooner than previously indicated. So what changed? One possibility, flagged by Luke Kawa of UBS Asset Management, is that some officials were concerned about downside risks to the economic outlook and public health situation back in March, even if they were generally optimistic about the shape of the post-pandemic recovery. Those officials might have supported zero interest rates through 2023 as a hedge, but would want to unwind that hedge once the data made it clear that the original baseline forecast was coming to pass. From this perspective, the level of interest rates under “appropriate monetary policy” hasn’t changed, only the level of uncertainty around the outlook. The apparent consensus earlier in the year would have been a mirage. These are extraordinary times as we slowly emerge from a devastating pandemic. Economists and analysts argue daily over what is happening in the economy and what should be done. “We shouldn’t be surprised that the members of the Federal Open Market Committee are finding themselves in a similar situation even if they all agree on what they want to have happen,” Matt says. Read his take here.