In a significant move by US Fed during their annual Jackson Hole, Wyoming, symposium which went virtual this year, Jerome Powell unveiled key changes made to what’s known as the committee’s “consensus statement” (Statement on Longer-run Goals and Monetary Policy Strategy) which has guided the Fed in its monetary policy actions.
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If you have watched Fed Chair’s announcement speech, it can be sound quite technical with many economic jargons. This is what we make of it (best effort basis) in a layman’s language:
- What is “consensus statement”? It’s a blueprint first adopted by Janet Yellen in 2012 where the committee agrees its policy actions will be guided to achieve a target longer run neutral rate (that which is growth without overheating or inflation) of 2% for the US economy. This fulfils their mandate of achieving price stability. Fed has two mandates – to ensure maximum employment and price stability for the US economy. For the former, the committee agrees that it will not be wise to set a desired target level of unemployment as there are factors of governance beyond Fed’s power like fiscal policies.
- However, what has puzzled the Fed for more than a decade now since the 2008 financial crisis, is that it has consistently failed in achieving this target inflation of 2% even with an economy powering ahead full-steam with full employment in 2019 before covid hit. In the words of Powell, the “Phillips curve has flattened” – the traditional relationship where an economy in full employment always lead to inflation and is the thrust behind why central bank must always tighten early.
- In the 2020’s update to the consensus statement, Powell held that three things will remain consistent – specifying a numeric goal for employment mandate is unwise, a 2% longer-run inflation target is still appropriate for Fed’s twin mandate, and that its monetary policy will always be forward-looking (based on incoming data).
- What is a material change in the consensus statement is that Fed will no longer aim to achieve a specific target of 2% inflation, but rather a longer-term average inflation rate of 2%. This means that if there is a substantial period of inflation hitting below 2%, Fed will then allow for considerable time for inflation to rise above 2%, in order that the long-term average inflation be maintained at 2%. It now sees no need for early monetary tightening, and is in fact, delighted with an economy at full employment and will like it run its course for as long as possible. It sees a strong labour market as particular good for lower-income communities as evident in the market in 2019, and would let the robust jobs market continue for years even if inflation overshoots 2%.
Much of this explained is still somewhat technical. I will simply interpret this change to mean that US Fed is now prioritizing full employment slightly more over price stability. It will be in no hurry to hike rates even when the US economy recovers from the covid-led recession.
Even if inflation starts to rear its ugly head and rises above 2% at some point (which I also doubt), the Fed is prepared to let economic growth continue without worrying about hiking rates for some time.
I do not know if subsequent Fed chairs will all abide by this consensus statement laid down in 2020, as pressure will mount should inflation rises out of control. Still, after decades of inflation being non-existent, this is not likely to happen anytime soon.
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For homeowners, the good news is – with the Fed now promising it will be very very patient and slow to consider hiking rates. This sustained period of fed funds at near zero will continue for quite a considerable time. Even if we get out of this imminent global recession in two short years and global growth bounces back – there will be a good chance of Fed remaining accommodative for long periods to sustain the growth over a decade. This does not mean zero rate hikes. But I would expect global interest rates to remain soft like Fed funds to remain below 1% or perhaps even below 0.50% for much longer than in the 08 crisis. It was 6 years when rates stayed down from 2009 to 2014. This time round it’s not inconceivable that it might take over a decade this time until we cross into 2030s.
This is in line with our forecast here that we are in for a sustained long period of “lower-for-longer” interest rate environment.
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