WASHINGTON: Amid market expectations the Fed may be forced to tighten monetary policy sooner than expected, top U.S. central bankers delivered a simple message to investors fixated on rising U.S. bond yields and price risks: Do not expect any changes until the economy is clearly improving.
Testifying on Wednesday before the House of Representatives Financial Services Committee, Fed Chair Jerome Powell emphasized the U.S. central bank’s promise to get the economy back to full employment, with little worry about inflation unless prices begin rising in a persistent and troubling way.
“We are just being honest about the challenge,” Powell told lawmakers when asked about Fed projections that inflation will remain at or below the central bank’s 2% target through 2023.
The Fed has said it will not raise interest rates until inflation has exceeded 2% and “we believe we can do it, we believe we will do it. It may take more than three years,” Powell said. The current inflation rate by the Fed’s preferred measure is about 1.3%.
An expected jump in prices this spring, he said, may reflect post-pandemic supply bottlenecks, or a jump in demand as the economy reopens, but nothing to warrant a policy response.
Powell’s remarks led a broad central bank effort to convince the public and particularly bond market investors that it is not going to tighten monetary policy until it is clear people are getting back to work.
Yields on U.S. Treasury bonds have risen recently, with the risk of a potential spike in inflation in focus as the United States expands its coronavirus vaccination program, plans further fiscal spending and moves toward a post-pandemic reopening of the economy.
Financial markets are pricing in a better outlook for the U.S. economy, and “that’s appropriate,” Fed Vice Chair Richard Clarida told the American Chamber of Commerce in Australia, adding he had become more bullish himself in recent months.
What that does not mean, he said, is any imminent change to the Fed’s near-zero setting for short-term interest rates, or its bond-buying program.
“We to a person are going to be patient, we are going to be very careful, and we are going to be very, very transparent of our intentions well in advance of any decision we might make in the future,” Clarida said.
Clarida said he sees inflation rising above 2% in the spring but coming back down to about that level by year’s end.
Talk about a possible market “taper tantrum” in response to a change in the Fed’s bond-buying program is “premature,” Clarida said. A taper tantrum refers to a rapid run-up in bond yields based on changes in market expectations for Fed policy.
“We have a deep hole, there’s still a ways to go, and I think that settings of monetary policy are entirely appropriate not only now but, given my outlook for the economy, for the rest of the year,” he said.
‘FRONT-RUNNING THE FED’
While some observers believe the Fed may need to remove crisis-era policies sooner than expected, that argument ignores the Fed’s new jobs-first framework, said Tim Duy, chief U.S. economist with SGH Macro Advisors.
“If we try to force the Fed into the old framework, we will be front-running the Fed. The Fed will not validate such front-running,” Duy wrote of Powell’s appearances this week before House and Senate committees. “The Fed intends to maintain easy policy until the data pushes it in another direction and the Fed does not expect that to happen for a long, long time.”
The Fed has said it plans to keep buying $120 billion a month in U.S. government and government-backed securities “until substantial further progress has been made” toward the Fed’s maximum employment and inflation goals.
With the inflation target a long way off, Fed officials have focused on what they see as a major gap in the labor market as well – a scar that goes well beyond the 6.3% headline unemployment rate to include concerns about disproportionate joblessness among minorities and the exodus of women from the labor force.
In recent weeks, Powell, Clarida and others have used an alternate measure of around 10% that includes, for example, those who have left the labor force in recent months, and even that may fall short of the damage to workers the Fed hopes to repair.
Powell, who testified in Congress as part of his mandated twice-a-year appearances on Capitol Hill to provide updates on the economy, said the Fed needed to see tangible progress before shifting gears, not just anticipated improvement, and not premature bets from the bond market.
“We are not acting on forecasts,” Powell said. The policy “is what it sounds like – incoming actual data that sees us moving closer to our goals.”
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