FOMC Update

Gary Pzegeo, CFA
September 21, 2020

A summary of the first Federal Reserve's scheduled meeting since the adoption of a new policy framework

Last Wednesday, September 16th, the Federal Reserve held its first scheduled meeting since the adoption of a new policy framework. The framework had been under review for several quarters and a change was expected. 

Changes of note

  • Making maximum employment a broad-based goal rather than having policy guided by deviations from maximum employment. In other words, the Fed will be more tolerant of low levels of the unemployment rate before adopting restrictive policy measures. This is essentially a downgrading of the relationship between unemployment and inflation (known as the Phillips Curve) in determining short term interest rates.
  • Adopting inflation averaging. The Fed will tolerate inflation that “averages 2 percent over time.” In the current environment where inflation has been persistently running below target, the Fed will aim for inflation moderately above 2% for some time.
  • Acknowledging a formal link between financial system stability and long run policy goals for employment and inflation. 

Analysts were looking to last week’s releases for clues on how the Fed planned to implement day-to-day policy within these broad parameters. What we find is a work-in-progress with some clear tilts toward more accommodative policy and some inconsistencies that require further explanation.

Current Conditions

Broadly speaking, the pandemic remains a significant challenge, but the policy response has improved economic and financial conditions in recent months. COVID-19 will continue to weigh on the outlook and poses considerable risks over the medium term. This is mostly unchanged from the Fed’s communication in July.

Policy

No new action. The target range remains at 0.00% - 0.25% and balance sheet expansion will continue at least at the current pace. At first glance, maintaining policy after adopting a more dovish framework seems inconsistent. The Fed has been adapting to economic and financial conditions in response to the virus and may have pulled some of the framework changes forward prior to its formal release.

Forward Guidance

The Fed made a number of changes to its post-meeting statement to align with the new framework. Notably, the Fed expects to keep rates at the current target range until they feel the economy has reached maximum employment and inflation has moderately exceeded 2% for some time. The Fed backed this up by extending its projection for zero interest rates to the end of 2023 from 2022 in its quarterly Summary of Economic Projections (SEP). Oddly, the Fed also projects that inflation will not exceed 2% over this new 3 year projection horizon.

Dissents

Two voting members, Kaplan and Kashkari, dissented with the release on the basis of policy flexibility and the phrasing of forward guidance. 

 

Gary Pzegeo joined the firm in 2007 as head of fixed income, focusing on portfolio management, trading, policy formulation and client service.