The onset of a recovery in the U.S. economy and the growing likelihood of a robust expansion this year and next resulted in a significant upgrade of the Federal Reserve’s Summary of Economic Projections forecast through 2023.
The Federal Reserve remains committed to achieving full employment, even at the risk of modestly higher inflation.
The dovish outlook on the committee is an apt description of the risks to the outlook from inflation, and the central bank continues to imply what will almost certainly be an increase in pricing this year will be transitory.
If investors did not believe that the Fed intends to achieve its policy goal of full employment even as inflation creeps modestly higher, its Summary of Economic Projections and Fed Chairman Jerome Powell’s press conference on Wednesday should leave no doubt.
The moderate decline in the yield on the 10-year U.S. Treasury would strongly suggest that the market has received the message loud and clear.
Despite a noticeable upgrade to the Fed’s growth and employment outlook, the majority of committee participants continue to see no change in the federal funds rate through 2023. Only four forecast a rate hike in 2022, and seven in 2023.
The Fed held the policy rate between zero and 25 basis points and signaled that it would continue to purchase $80 billion in Treasury securities and $40 billion in mortgage-backed securities per month.
The Fed upgraded its growth forecast for 2021 from 4.2% to 6.5%, its 2022 estimate to 3.3% and 2023 to 2.2%. Perhaps more importantly, given that the Fed is focused on full employment, which it defines as 4% (RSM estimate is at 3.5% or lower), the committee expects a 4.5% unemployment rate this year, 3.9% in 2022 and 3.5% in 2023.
Those forecasts should underscore the seriousness of the Fed to achieve its policy goals even as it now expects its core inflation variable — year-over-year core PCE — will run at or near 2% through 2023.
Over the longer run, the SEP implies that the long-run growth rate of the U.S. economy stands at 1.8% per annum and the median federal funds rate should rise to 2.5%.
The Fed did not announce any extension of the supplemental reserve ratio for banks nor did it lift the rate on interest paid on excess reserves or overnight reverse repurchases. It did, however, increase the size of reverse repurchases from $30 billion to $80 billion per counterparty, which should assuage concerns within the primary dealer community that makes markets for the Fed that the central bank is sensitive to risks around the front end of the curve.
We continue to expect that the Fed will extend the supplemental leverage ratio over the next two weeks. Not doing so in our estimation could result in tighter financial conditions and tighter lending conditions for small and medium-size enterprises.
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