As expected, the Federal Open Market Committee (FOMC) did not announce a major shift in monetary policy following the July meeting. The Fed statement included only minimal changes to reflect the economic recovery seen in May and June, while during the press conference, Fed Chair Jerome Powell emphasized the importance of the path of the pandemic on the economic outlook, noting the concerning pace of virus spread and loss in economic momentum evident in the higher-frequency indicators of consumer spending and hiring in July.
Since the last FOMC meeting, there have been two main economic developments. First, the rise in new COVID-19 cases and hospitalizations in various regions of the U.S. has accompanied a loss of economic momentum, which started in July. And second, the likely size of an additional fiscal stimulus package has grown – we now expect Congress to pass another $1.5 trillion to $2 trillion in additional economic support. These two factors have offsetting implications for the near-term outlook for growth, supporting the Fed’s decision to be patient at the July meeting and await further clarity.
Powell also hinted that in September, the Fed could release the conclusions of its multiyear review of monetary policy strategy, at which point we expect the Fed also will announce stronger forward guidance on interest rates and asset purchases. The Fed’s objective is shifting from managing a major financial market crisis toward keeping monetary policy conditions easy, and we think Fed officials will reveal their commitment to keeping rates steady until they are certain that inflation will sustainably achieve the 2% PCE (personal consumption expenditures) inflation target. To be sure, they are likely already operating under this notion, but the September announcements will likely make it clear to markets through the strategy review conclusions and also the addition of 2023 forecasts to the summary of economic projections (SEP), which could show still-low rates and forecasts for above-target inflation. This policy strategy draws on studies and conversations with the public about the economic benefits – including the labor market benefits to lower-income wage earners – of running the economy above potential.
Given the recent loss of economic momentum, it’s also possible that the Fed adjusts its purchases of U.S. Treasuries and agency mortgage-backed securities (MBS) to provide more accommodation. In any case, we believe asset purchases will be maintained at least through 2021, and rates will be on hold through the majority of 2023, if not longer. Still, with long-term rates near historically low levels, and the market fully pricing in a rate hike in mid-2024, we don’t expect a major reaction in the government bond market to the Fed’s upcoming announcements.