Uncertainty remains around the implementation of average inflation framework, despite the Fed’s best efforts.

New Fed Framework: From Preemptive to Reactive

The FOMC kept to its recent narrative by making minimal changes to its prepared statement, leaving monetary policy rate unchanged at zero lower bound range of 0.00 – 0.25%, but increasing economic projections in an attempt to message a new reaction function and minimize the uncertainty around its commitment to the new inflation targeting framework.

Key takeaways

Statement: There were minimal changes to the statement and no changes to QE or key administered rates. In the implementation note, the FOMC increased the counterparty limit on overnight reverse repurchase agreements from $30bn to $80bn.

Fed Fund Projections: The dots remained dovish and unchanged from December median projections. Although two additional FOMC members (for a total of seven) projected at least one rate hike for 2023, it was not enough to move the median dot.

Economic Projections: Summary of economic projections (SEP) seems to adjust for the stimulus package and increasingly successful vaccination; 2021 projections were significantly better for the GDP, unemployment rate and core PCE Inflation while the long-run estimates were mostly unchanged.

New Reaction Function: Chairman Powell clearly articulated the change in the Fed reaction function, stating that “fundamental change in our framework is that we’re not going to act preemptively based on forecast, for the most part and we’re going to wait to see actual data. And I think it will take people time to adjust to that and to adjust to that new practice and the only way we can really build the credibility of that, is by doing it.”

Conclusion: It confirms that the FOMC intends to be far more dovish than prior regimes— the current economic projections would have been consistent with a hawkish Fed in the past. This Committee is embracing its new policy framework and sticking to its guns in anchoring front-end rates, allowing it to doggedly stay at the zero bound with extreme caution without having to downplay a rapidly improving economic outlook.

Investment Implication: It’s our belief that in spite of the committee’s attempt to solve the uncertainty around the implementation of its framework, it still leaves the market in the conundrum of embracing the easy policy that continues to fuel risky assets while doubting the Fed’s ability to deliver on its promise if inflation overshoots. That, in turn, might keep interest rate volatility elevated and point to higher long-end real yields in the near term.