Fed Monitor: Glass half empty or half full?

Key takeaways

• On one hand, the Federal Reserve was not as dovish, as we had expected, but on the other hand not as hawkish as others had expected leaving the glass half empty/full. Basically, the message was “keep calm and carry on”, as the Federal Reserve will not hike rates until 2024 at the earliest.
• We think the meeting was a slight disappointment making it harder for the Federal Reserve to achieve its new inflation goal of 2% average inflation. We no longer expect increasing QE buying pace unless we see an economic setback or a more significant risk off.
• In our view, Powell’s press conference will likely mean the USD-negative reflation story is set to pause a bit longer. We now see the EUR/USD range as shifting from 1.18- 1.20 to being 1.17-1.19 but stick to our call of 1.23 in 6M time (see page 2).

Actions speak louder than words

On one hand, the Federal Reserve was not as dovish as we thought, as it did not increase the QE buying pace. On the other hand, it was not as hawkish as other had expected, as it changed its forward guidance reflecting the new regime. So is the glass half full or half empty then? The answer is: it depends. This probably also explains why markets cheered at first but later reversed. 10yr breakeven inflation rates ended the day marginally below where they were just before the announcement. Overall, we think the meeting was a slight disappointment making it harder for the Federal Reserve to achieve its new goal of inflation averaging 2% over time. For now we do not expect further easing from the Federal Reserve taking out our call for more QE, at least until we get stronger signals. Unfortunately, the Federal Reserve is not as supportive for the recovery, as it could have been, which also means that the reflation theme will not be a strong as it could have been.

So why is the glass half full? The Fed maintained its target range unchanged at 0.00-0.25% and linked future rate hikes to realised inflation outcomes stating that “it will be appropriate to maintain this target range until labour market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time”, very much in line with our expectations of a change in forward guidance reflecting the new flexible average inflation targeting regime.

During the press conference, Fed chair Powell made clear that “maximum employment” should be interpreted differently, as it is now a more “broad-based, inclusive goal”, i.e. the Fed will not tighten monetary policy just because the unemployment starts to fall significantly and in that way the tightening cycle after the Covid-19 crisis will be much different from the tightening cycle after the great financial crisis. Looking at the economic projections, the Fed is not expecting to raise rates through 2023.