The context for today’s Federal Open Market Committee (FOMC) meeting had a number of crosscurrents. On the one hand, the US economy has handily outperformed consensus expectations over the last few months. Consensus forecasts for growth and employment have been upgraded accordingly. On the other hand, the economic damage caused by Covid is still quite substantial (payroll employment remains 10 million jobs below where it was in February), and there are real concerns about the unevenness in the recovery across sectors and income groups.
Likely due to these multiple crosscurrents, many members of the FOMC had indicated a desire to wait for more clarity on the economic outlook before announcing any changes to policy. While the desire for clarity is perhaps understandable, waiting to make policy announcements risks undermining investors’ confidence in the Fed’s ultimate goals. Fed Chair Powell has previously said that the public should count on the Fed to be there to support a vigorous recovery. That type of statement suggests that the Fed’s support is not conditional on how exactly the next few months play out. To the contrary, in order for the public to have confidence in the Fed’s commitment, the understanding should be that the Fed will be there to support the recovery regardless of how the next few months unfold.
The FOMC decided today that it was better to go ahead and make some policy announcements sooner rather than later. Specifically, the post-meeting statement introduced forward guidance on the future path for interest rates. The acceleration of the forward-guidance announcement, even though the outlook remains somewhat unclear, was a surprise to many who thought the desire to wait for clarity would carry the day.
The guidance was also somewhat more ambitious than many expected. In particular, the guidance specifies a three-part test, in which all three criteria must be met to justify an increase in interest rates. In order for the FOMC to raise interest rates: (1) inflation must have “risen to 2%,” (2) inflation must be “on track to moderately exceed 2% for some time” and (3) the labor market must be at “maximum employment.” This is the first mention of inflation exceeding 2% in an official post-meeting statement. By including it today the FOMC is promising to make good on the new average inflation targeting framework. The “maximum employment” condition is also notable. The focus on employment is consistent with the emphasis in Powell’s Jackson Hole speech at the end of last month. Moreover, as any student of undergraduate statistics can tell you, specifying a third condition necessarily lowers the probability that all the conditions will be met in a given period.
The announcements today were incomplete, however, as the FOMC left unanswered a number of questions about its asset purchase program. The post-meeting statement did include that the Fed will continue to purchase assets at least at its current pace ($80 billion of Treasury securities and $40 billion of MBS per month), and it also characterized those purchases as “fostering accommodative financial conditions.” What remains unclear is how long those purchases will continue and whether there will be any changes to the composition of purchases. Powell was pushed on both points during the press conference. His responses indicated that the FOMC has not yet decided, but it is considering all of the various dimensions of the program.
Our view had been that the magnitude of the current economic challenges, together with an unmistakably accommodative bias from Fed policymakers, meant the odds favored that the FOMC would continue its purchases for some time and eventually adjust its purchases toward longer-dated securities. The lack of progress today has made that outlook less clear, although it’s important to note that no options have been ruled out and the debate is ongoing. At a higher level, leaving questions unanswered may have the unintended consequence of undermining investors’ confidence in the Fed’s commitment. That would be a shame, especially as the Fed appears to have gone out of its way to accelerate the forward guidance announcement in order to address precisely that type of issue.