The Zero prevails despite US economy running hot

Despite the selloff in Treasury bond markets the US Federal Reserve (Fed) stuck to its dovish stance.

Members of the Fed’s Open market committee (FOMC) upgraded their projections for US GDP growth, but signalled that there would be no increase in interest rates before the end of 2023.

The FOMC now expect the US economy to expand by 6.5% this year (previously 4.2%) before moderating to 3.3% in 2022.

Inflation is expected to be slightly higher, but the profile is unaltered and core CPI is projected to be 2.1% at the end of 2023. The near term pick-up in inflation is expected to be transitory and looking further out the Fed does not see its forecasts as sufficient to trigger higher interest rates, with the median fed funds projected at 0.1% out to 2023.

At his press conference Fed chair Powell was dovish and argued that the recovery would take time and that policy needed to remain accommodative. It was too early to talk of adjusting asset purchases (QE). In the meantime he is prepared to run the economy “hot” to meet the central bank’s objectives.

Prior to the meeting there had been an expectation that the Fed would signal a lift-off in interest rates in 2023 alongside upgrades to growth and lower unemployment.

That would have been the case under previous, more pre-emptive Fed regimes, but the change in the central bank’s mandate to average inflation targeting and maximum employment means that we will have to actually see higher inflation first.

For investors, the key takeaway is that zero rates and Fed liquidity will continue as growth accelerates later in the year.

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