What the Fed’s Policy Shift Means for Inflation and the Labor Market | Lord Abbett
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Economic Insights

Remarks by U.S. Federal Reserve Chair Jerome Powell indicate a tilt toward economic stimulus in the longer term.

Read time: 2 minutes


In an August 27 speech, U.S. Federal Reserve (Fed) Chair Jerome Powell outlined key shifts in the central bank’s approach to monetary policy, especially with regard to inflation and unemployment levels.  While nothing that the Chair said was a major surprise, the timing of the announcement and the inter-meeting vote by the Federal Open Market Committee (FOMC), the Fed’s policy-setting arm, that approved the new “Statement of Longer Run Goals” suggested that the committee is clearing the decks for a meaningful shift in policy at its September 15–16 meeting. This would involve a change in strategy to provide stimulus for U.S. economic recovery as opposed to the support for “market functioning” the Fed has been emphasizing during the COVID-19 shutdown period.

Despite Powell’s speech largely affirming the status quo, there were certain nuances that suggested the Fed would be making some alterations to its policy implementation framework in response to a changing economic environment. These included:

  1. An explicit statement that the Fed would allow inflation to run above 2% in the latter stages of economic expansions to compensate for sub-2% inflation after recessions. Thus, the Fed reaffirmed that the inflation target is symmetric around 2%, as it has been insisting for many years.
  2. Policymakers would err in favor of stronger economic growth by delaying interest rate increases in order to promote maximum employment and allow the benefits of a strong labor market to filter down more strongly to disadvantaged groups. We take this to mean they will not repeat the “mistake” they made during the “taper tantrum” in 2013 when they tightened pre-emptively and investors interpreted that as indicating that 2% inflation was a ceiling, not a symmetric target.
  3. The Fed expects to use quantitative easing and forward guidance indefinitely in order to strengthen its ability to implement stimulative policy in a low interest rate environment. Everything that was unconventional before 2008-2009 has now become conventional.

Policy and Investment Implications

One thing that was missing for some observers was a commitment to specific targets for how high inflation would be permitted to rise above 2% and how much the labor market had to tighten before the Fed starts implementing restrictive policies. In the absence of those markers, the Fed retains broad discretion to implement policy as it sees fit—and that includes just continuing to do what they have been doing up to now. Moreover, a new set of policymakers joining the FOMC after the 2020 U.S. election need not feel bound by any previous commitments the Fed has made. In that sense, and considering that central banks are conservative institutions that need to be mindful of a broad range of interests in order to safeguard their independence, not much really changed as a result of the 18-month policy review that was just concluded. Thus, we believe the accommodative U.S. monetary policy that has supported asset markets is likely to remain in place for some time.

 

The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. U.S. Treasuries are debt obligations issued and backed by the full faith and credit of the U.S. government. Income from Treasury securities is exempt from state and local taxes. Although Treasuries are considered to have low credit risk, they are affected by other types of risk—mainly interest rate risk (when interest rates rise, the market value of debt obligations tends to drop) and inflation risk. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee. 

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Fed refers to the U.S. Federal Reserve.

Taper tantrum refers to the 2013 fixed-income market action that included a spike in U.S. Treasury yields after investors learned that the U.S. Federal Reserve was slowly winding down its quantitative easing (QE) program.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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