U.S. central bankers find themselves in the most difficult of positions. They need to begin accommodating what will be a multiyear period of large annual operating deficits without appearing to subordinate monetary policy to the needs of the U.S. Treasury.
We expect the federal funds target rate to remain at 0.0% to 0.25%.
That issue will be on display in multiple ways when the Federal Open Market Committee meets on Wednesday — in the Fed’s policy statement, the dot plot, its summary of economic projections and, later, in the news conference by Federal Reserve Chairman Jerome Powell.
The Fed will of course never acknowledge this, but we will soon enter the era of post-pandemic economics that will feature stratospheric government deficits necessitating the turn to a seldom used policy called yield curve control. That policy targets long-term interest rates at a specific level that is then achieved by a central bank buying or selling as many bonds as necessary to hit that target rate.
We expect no major changes in the Fed’s target range for the federal funds rate, which will be left at 0.0% to 0.25%. Given the clear economic risks for an economy gently emerging from the recession’s nadir, the interest on excess reserves will be left at 0.10%.
The dot plot, which is what the market takes as the Fed’s interest rate forecast, will reinforce the forward guidance from the central banks with the median dot plot indicating no interest rate hike through the end of 2022, which is the end point of the Fed’s forecast horizon.
We expect the median dot to ease from 2.5% to 2.25%, given the Fed’s inherently conservative nature.
About the only thing that will be of interest is if one participant chooses to place a negative sign in front of quarterly rate forecast. We do not anticipate that happening, but think it could be a close call given the divergence of opinion on this throughout the Federal Reserve system, despite the united front publicly. At one point, the Fed will move to refine that forecast, but we do not anticipate that occurring this week.
In fact, we think that the Fed will need to refine both its summary of economic projections and its forward guidance on its path of bond purchases in advance of any policy shift to capping yields or yield curve control. For this reason, we think any calls for a move to adopt yield curve control are entirely premature at the June FOMC meeting.
The June statement will without a doubt note the surprisingly strong May jobs report, but will otherwise retain the cautious tone that has defined much of the Fed’s recent rhetoric. One should anticipate the use of “considerable risks” and “tremendous human and economic hardship” to overall define the Fed’s economic and policy outlooks.
The June summary of economic projections will almost certainly point to a near 6% decline in 2020 growth and a 3.5% rebound in 2021. We think that the year-end unemployment rate forecast will land near 10% and the summary of economic projections to note some risk of disinflation with the pricing forecast arriving well below the 2% target though the end of the 2022 forecast horizon.
When one ascertains the inflation and rate forecast through the end of 2022, it should reinforce that there will be no upward move in rates for the foreseeable future and that the Fed is setting up for a policy shift to yield curve control later this year or early in 2021.
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