Fed: Striving to be average – CIBC
The Federal Reserve announced on Thursday it has adopted a new strategy for monetary policy that will tolerate higher inflation signaling the central bank. Royce Mendes, economist at CIBC points out that unlike in the past, when the Fed tried to raise rates ahead of seeing inflationary pressures so as not to allow price pressures to overshoot, policymakers will be more willing to see how far they can push the unemployment rate lower.
Key Quotes:
“Up until now, the Fed was not focused on past shortfalls or overshoots. But a recent review of the central bank’s framework highlighted the challenges posed by the persistently low interest rate environment. The updated strategy explicitly acknowledges those challenges and tries to address them by pushing inflation expectations higher. The hope is that will help push nominal interest rates up over time, moving them away from the binding constraint of the zero-lower bound. That constraint was on full display when the central bank could, in the face of the largest negative shock since the Great Depression, only cut its main policy interest rate by roughly half of what’s generally been needed to offset an average recession before hitting the lower bound.”
“The Fed also altered the language it uses to describe what it is looking for from the labor market. It will now make policy decisions based on its assessment of the shortfall in employment rather than deviations from its maximum level. The change reflects the central bank’s view that what would have previously been viewed as a robust labor market can be sustained without generating an aggressive rise in inflation. As a result, it will lean heavily on realized inflationary pressures to inform its assessment of full employment.”
“The initial market reaction to the changes saw yields move lower, appearing to be the result of the anticipation of such changes ahead of the release. However, yields are now hitting multi-day highs with the new strategy generating a lot of chatter among investors.”