Update: FOMC willing to let the economy rip for now

Forex 3 minutes to read
John Hardy

Head of FX Strategy

Summary:  The Fed decision today look supportive for risk sentiment and for a weaker US dollar, as the Fed projected much stronger growth this year and higher inflation without raising the median forecast for the timing of the first rate hike, which remains for 2024. This suggests the Fed is more than willing to let the economy run hot for now without reacting with leaning against inflationary pressures.


The Fed decision today initially triggered a USD sell-off and a reduction in rate hike bets from the Fed for 2022 and 2023 as the market interpreted the combination of an almost unchanged FOMC policy statement with some fairly large, and very interesting adjustments in the GDP and especially inflation projections. The “dot plot” of rate projections saw only three more members forecasting liftoff by the end of 2022 (versus only one member in December), and only two additional members, relative to December, predicting one or more rate hikes in 2023 (seven versus five in December). That still leaves the median forecast at no lift-off until 2024 rolls into view.

A few short observations:

  • The statement merely saw the very slightest of upgrades in its observation of the economy: “indicators of economic activity have turned up recently, although the sectors most adversely affected by the pandemic remain weak. Inflation continues to run below 2 percent.”  The January statement noted ”moderated” growth and a more vague statement on inflation being held down.
  • The obviously stale December projection of 2021 GDP growth of 4.2% received a hefty upgrade to 6.5%, while interestingly, the Fed chose to only marginally upgrade the 2022 GDP 0.1% to 3.3% and actually revised down (??) the GDP for 2024 to 2.2% from 2.4%.
  • The PCE inflation projections are a bold bet that inflation could surge for the rest of this year but moderate from there, with 2021 PCE core revised higher to 2.2% from 1.8%, while the 2023 and 2024 projections were only raised 0.1% to 2.0% and 2.1%, respectively.
  • Unemployment rate projections were also lowered – to 4.5% by the end of this year and 3.5% by 2023, versus 5.0% and 3.7%, respectively, previously.
  • The Fed chose to up the maximum amount any single entity could access at the repo window to $80 billion from $30 billion previously, an assist to liquidity at the shortest end of the yield curve, where yields were risking turning negative on a huge wave of liquidity as the US Treasury unwinds its holdings at the Fed to pay for the stimulus.

Conclusion
On balance, the combination of sharply improved projections for the near term course of the economy and inflation and unemployment relative to an unchanged Fed funds policy forecast (median, of course) is quite bullish for risk and bearish for the US dollar, with the only caveat that a significant rise in long US yields in the belief that the Fed and the US government are over-stoking the economy, and lead to extremely high long-term interest rates could create headwinds for interest rate sensitive equities and eventually all risk assets if the move gets disorderly. On that note, the longer end of the US yield curve looks quite stable after posting new highs in yields earlier in the day before the FOMC announcement, while rate hike bets for 2022 and 2023 were pulled back to the middle of the recent range.

Note that all comments above are before any further elucidation at the Fed Chair Powell Press Conference.

There was no mention of the SLR (supplemental leverage ratio) issue, with that rule set to expire at the end of the month, which doesn’t seem to have perturbed markets. (At beginning of presser, Powell said that something would be forthcoming “in coming days"

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