- The minutes from the January 26-27 Federal Open Market Committee (FOMC) meeting emphasized the need for consistent messaging that monetary policy will remain loose until there are clear signs that the economy has moved past the pandemic.
- The members of the Committee made it clear that the policy rate should stay at the floor and that Quantitative Easing (QE) should be maintained given the uncertainty surrounding the economic recovery. This was made obvious in the minutes, which stated, “the ongoing public health crisis would continue to weigh on economic activity, employment, and inflation and posed considerable risks to the economic outlook.”
- Even through this tremendous uncertainty, Committee members were cautiously optimistic about the economic recovery, stating, “the stimulus provided by the passage of the [fiscal package] in December, the likelihood of additional fiscal support, and anticipated continued progress in vaccinations would lead to a sizable boost in economic activity.”
Key Implications
- In spite of the Fed’s cautiousness, there has been a lot of good news of late. Congress is expected to pass a near-$2 trillion fiscal package that will put money in the pockets of Americans that are being negatively impacted by the pandemic. That will improve their financial situation and allow for an even stronger recovery once the health crisis passes. Already over 55 million Americans have received a vaccine. This pulls forward the timing of that economic bounce-back to as early as this spring.
- Financial markets have already started to price in this reality. The U.S. 10-year Treasury yield has continued to rise and now sits at 1.3%. That is 0.8 percentage points higher than the lows of August 2020. As the economic recovery becomes more obvious in the coming months, we would expect yields to keep rising.
- Our expectation that yields will move higher is based on our view that GDP will recover to pre-pandemic levels by mid-year and that core inflation will reach 2% by year-end. Though we are optimistic that the economy is on the right track, the Fed will only believe it when it sees it. As a result, we don’t expect it to ease off its monetary support anytime soon.
