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Our take on the Fed: the Fed’s stealth easing continues.

What Does That Mean?
We’ve seen the US forecast for GDP revised higher, unemployment revised lower, and inflation revised higher. Yet the Fed member forecast (also known as the “dot plot”1) for rates has remained unchanged. Expectations for better growth with lower unemployment and higher inflation while keeping interest rates unchanged are modestly dovish.

What Made Us Go “Hmm…”?
Looking at the dot plot, December 2020 saw 16 of 17 members of the Federal Open Market Committee (FOMC) forecasting to keep rates unchanged for 2022. Those numbers shifted on March 17, with 14 of 18 members expecting no change. Put another way, four members are now forecasting a hike in 2022, up from just one in December 2020.

December 2020 rate forecasts for 2023 had 5 of 17 members calling for a rate increase. As of March 17, that number shifted to 7 of 18 members – an increase of two more members expecting a hike in 2023.

Importantly, these shifts were not enough to change the median expectation, which still calls for rates to remain on hold throughout 2023. However, we do take note that a few members seem to be getting a little uncomfortable with that outlook.

Another big question is, whose dots shifted? The dot plot is anonymous. The FOMC has both voting members and non-voting members. If it was non-voting members, maybe the news is less relevant?

So What? Powell Can Herd Cats.
If it was voting members, there remains time for Fed Chairman Jerome Powell to get them on board with his thinking on the average inflation targeting framework. We’ll be watching to see the evolution of this management of the governors.

What Else Made Us Go “Hmm…”?
The wide end of the core personal consumption expenditures (PCE)2 forecast for 2021 hit 2.5%, according to the Fed’s economic projections. That number comes down to 2.3% for 2022 and 2023. This implies that inflation will top out at 2.5%. Is this because inflation will prove to be transient? Or that the Fed will hike to put a lid on it? The projections leave us wondering. But after all, they’re just projections. The real measuring stick for policy decisions is actual progress not forecast progress.

Chair Powell Continues to Stress the Uneven Recovery. What Does This Mean?
The Fed has a dual mandate: price stability and full employment. Given his comments on March 17 and comments in previous speeches – as well as sentiment echoed by former Fed Chair and current Treasury Secretary Yellen – the latter seems to be taking a bit more precedence. Full economic employment is one way in which the Fed can attack the issue of income inequality, a key theme espoused by the Biden administration.

We’ve heard from Powell about several key indicators in terms of quantifying this inequality:
  • Black unemployment
    • Pre-pandemic (February 2020): 6.0%
    • Currently: 9.9%
  • Low wage earners wage growth (bottom 25% quartile)
    • Pre-pandemic (February 2020): +4.7%
    • Currently: +4.0%
    • Previous downturns have taken an average of 3 years to recover
  • Labor force participation rate for those without a college education
    • Pre-pandemic (February 2020): 58.3%
    • Currently: 54.7% (lowest since data has been recorded)
We are very far from meeting these key indicators in terms of meeting the full employment mandate, and it’s going to take quite some time for these gaps to close. Large gains have been and will likely continue to be made quickly, but removing that final bit of labor market slack can prove more challenging. It may prove particularly challenging as businesses restructure to become leaner and more efficient in the post-pandemic world, resulting in potential frictions for re-employing those who have lost jobs. Hiking rates too soon could very well leave these gaps well short of what would likely be seen as an acceptable economic recovery.

The Market Continues to Hear What It Wants to Hear.
This continues to be a head scratcher. Powell continues to stress that he is now data-driven, not pre-emptive. Models are out. Actual inflation is in. Full employment could very well be priority one, while price stability takes a back seat.

Remember, the Fed wants three things to happen before they hike:
  1. Full employment
  2. Actual inflation above 2%
  3. Inflation forecasts calling for inflation to be > 2% for a persistent time
We are far from checking the box on any of these things, and yet the market continues to want to “test the Fed’s resolve.” Maybe once – just once – the market will actually take Powell at his word, because he’s been saying what he plans to do since the day he took the seat as Fed Chair in February 2018.
Yet the market thinks otherwise.

What About the Markets?
The stealth easing probably means higher equities and a steeper curve. The market will continue to doubt the Fed, and this means inflation expectations are likely to continue to rise. Firming inflation this year will only add to this, despite well-known base effects and emerging and resolving supply/demand imbalances. But at some point, the market will need to stop extrapolating the current trends into infinity.

Just remember, financial conditions matter more. It’s not just about rates. Financial conditions are all-encompassing, not narrowly defined by nominal rates. Financial conditions have continued to ignore the rise in nominal rates. They remain extremely loose and extremely accommodative.

1 In finance, the Federal Reserve uses a dot plot to signal its expectations of future interest rate changes. In a Fed dot plot, each member of the FOMC is represented by a single dot, but each dot is anonymous.

2 The "core" PCE price index is defined as personal consumption expenditures (PCE) prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.

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