FOMC: avoiding a recession is more important than avoiding the risk of overheating - BBVA

William De Vijlder, analyst at BNP Paribas, points out that the Federal Reserve has an “asymmetrical loss function: avoiding a recession is more important than avoiding the risk of overheating”. He added that the Fed’s tone remains cautious despite upbeat growth projections.

Key Quotes: 

“The Federal Reserve faces two asymmetries. The first is the asymmetric loss function. This is largely by choice because it wants to avoid triggering a recession (fighting recessions has become increasingly difficult). Chairman Powell insisted in his press conference on Wednesday on the need not to tighten too quickly. Otherwise inflation would rise insufficiently which would make it more difficult to tackle the next recession when it comes. The second asymmetry is imposed on the central bank.”

“Engineering an uplift in inflation towards the 2% target looks like a huge task. Faced with these two asymmetries, insisting that the inflation objective is symmetrical, like Jerome Powell re-iterated on Wednesday, becomes an obvious, not to say inevitable, conclusion: allowing a temporary inflation overshoot is the price to pay for the wish to avoid the most uncomfortable part of the loss function (a recession) that could ensue from what would turn out to be a prematurely restrictive policy stance.”

“Nobody seems to believe in the resurrection of the Phillips curve. All this helps explaining the relaxed reaction of bond markets: a temporary inflation overshoot won’t stop the Fed from sticking to a gradualist approach and if the FOMC has doubts about the Phillips curve, why speculate against this? At the end of the day, financial market positioning has become as data-dependent as central bank policy.”