Fed’s hawkish tilt is just the start

The latest meeting of the Federal Open Market Committee brought no change in policy settings, but a clear and in our opinion timely tilt toward tighter policy in the future.

There was little change in the accompanying policy statement, except that the Federal Reserve (Fed) does seem to be acknowledging that Covid-related downside risks have been reduced by the vaccination programme’s progress.

The focus of the statement released following the two-date FOMC meeting was very much on the Fed’s economic projections and the “dot plot”, its chart representing the interest rate forecasted by 18 members of the committee.

Upgrades to the growth and inflation forecasts for this year were not a surprise, but the increase in the number of FOMC members looking to raise interest rates by the end of 2023 did catch the markets off guard.

The median dot for the end of 2023 moved up to 0.625%. Consensus going into the meeting was that there would be no change from current levels. There was also a noticeable increase in the number expecting higher rates by the end of 2022, although the median dot remained unchanged on this time horizon.

In his press conference, chair Powell acknowledged that the committee was now “talking about talking” about tapering and “the possibility that inflation could turn out to be higher and more persistent than we expect” given the bottlenecks in re-opening the economy.

The Fed’s projections make clear that the pick-up in inflation is seen as transitory, but there has been a significant shift in expectations for this year following recent data.

These moves bring the Fed closer to our own projections, where we forecast that the central bank will begin tapering at the end of this year and raise rates at the end of 2022.

Our view is driven by the strength of growth we are likely to see in the second and third quarters of this year and an ongoing positive outlook. This means we have concerns that the economy will be heading for higher inflation even if the current pick-up proves transitory.

We do expect inflation pressures to ease later this year but then to rise again in 2022 as the output gap closes and the economy overheats. The Fed will find it difficult to be passive in this environment and will have to act to prevent a significant rise in inflation expectations, which of course would feed a sustained rise in inflation through stronger wage growth.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. The content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.