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Economic Study 1/7/2020 1

Fed opts for status quo out to 2021 at least

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Bruno Cavalier
Chief Economist at ODDO BHF

The Fed has left its policy rate range unchanged, reflecting the end of the midcycle easing (-75bp) prepared in the Spring and implemented in July, September and October. The central bank henceforth expresses no bias, which means that status quo is seen as the optimal option until further notice. There is no inflation risk in the foreseeable future. There are still downside risks to activity, but they are no longer considered of sufficient intensity to justify a policy rate cut. The yield curve has resumed a normal configuration (long-term interest rates > shortterm rates) over the past two months.

The week's focus

What a change in one year!

  • December 2018: the Fed described employment conditions as "strong" and risks to the outlook were seen as "roughly balanced". December 2019: the Fed considered job creation to be "solid" and the reference to "uncertainties" in the preceding press releases was omitted.
  • December 2018: the Fed raised its policy rates for the ninth time since 2015; its plan was to pursue this direction throughout 2019 with three additional rate hikes and an automatic balance sheet reduction at a maximum rate of $ 50bn per month. December 2019: after three rate cuts and balance sheet expansion of almost $200bn to provide banks with more liquidity, the Fed had no plans to raise rates until 2021 at the earliest, and even then still modestly (chart lhs).
  • December 2018: the markets are panicked by the Fed's "mistakes". December 2019: the markets face no risk of imminent monetary policy tightening.

It is rare, perhaps unprecedented, that the Fed would conduct such a marked shift in policy stance, without any radical change in the economic outlook. This reflects great aversion to the risk of recession, perhaps out of concerns at not having the usual leeway to respond to it, but above all it reflects the ebbing of the risk of inflation. The Fed deems that unemployment can remain low without generating pressure on wages and prices. FOMC members expect unemployment to remain under the 4% threshold for several years without fearing a spiralling of inflation (chart rhs). Questioned as to whether the labour market was strained, Jerome Powell indicated that there is only one way to be sure and that is to wait for a real surge in wages. These comments suggest that the Fed is ready to go to this limit. The notion that a period of overshooting the inflation target of 2% is tolerable – and even desirable – after a lengthy period of undershooting, is now the key plank underpinning the Fed's monetary policy. 

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