The Federal Reserve used the annual Jackson Hole Economic Policy Symposium today as a platform to announce the updates to the long-run goals. The Fed will now seek an average inflation target of 2% over time and assess the shortfalls of employment from the maximum level.
From the Press Release:
“The economy is always evolving, and the FOMC’s strategy for achieving its goals must adapt to meet the new challenges that arise,” said Federal Reserve Chair Jerome H. Powell. “Our revised statement reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation.”
Among the more significant changes to the framework document are:
- On maximum employment, the FOMC emphasized that maximum employment is a broad-based and inclusive goal and reports that its policy decision will be informed by its “assessments of the shortfalls of employment from its maximum level.” The original document referred to “deviations from its maximum level.”
- On price stability, the FOMC adjusted its strategy for achieving its longer-run inflation goal of 2 percent by noting that it “seeks to achieve inflation that averages 2 percent over time.” To this end, the revised statement states that “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”
- The updates to the strategy statement explicitly acknowledge the challenges for monetary policy posed by a persistently low interest rate environment. Here in the United States and around the world, monetary policy interest rates are more likely to be constrained by their effective lower-bound than in the past.
The Treasury market’s initial reaction is a curve steepening. The front-end of the curve is pegged to the current Fed Funds Rate while the long-end of the curve believes that the Fed will inevitably hold rates low for too long and generate inflation that they are unable to control. We disagree.
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U.S. Treasury Curve August 1, 2020 vs. August 27, 2020
Source: Bloomberg 8/27/20
While the next 12-months will be influenced by a base effect as we work through the economic shutdown induced impacts on the inflation data – very low YoY inflation currently will provide a pop 12-months from now – the temporary base effect adjustments will fade and leave the inflation level running near 2% again.
Recall that post the 2007 recession, inflation via Core CPI and Core PCE marked a high print of 2.4% YoY and 2.2% YoY. These are not levels that either the market or the Fed would consider “out of control inflation.”
The Fed has been clear that rates will remain accommodative for a long period of time. We believe there will be a disconnect between the market’s view on growth and inflation vs. actual growth and inflation. The square root recovery is taking shape – a quick drawdown and snapback followed by a plateau. The outcome of what we believe will be a disconnect between the market and the Fed will create a great environment for active investors. We will be able to utilize duration management to position around the future market volatility.
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