Written by: Tim Benzel, CFA, VP & Sr. Portfolio Manager
The Federal Reserve Open Market Committee (FOMC) met last week to discuss and set monetary policy. As was widely expected, the Committee left the Fed Funds Rate unchanged at the 1.5-1.75% targeted range and made very few adjustments to the post-meeting statement. Many FOMC participants have publicly shared their desire to wait and see how the three Fed Funds Rate cuts last year will impact the economy in early 2020.
More importantly, in our view, was a discussion in the post-meeting press conference around the optimal inflation target sought out by the FOMC. Along with full employment, the Fed has a mandate to maintain price stability, which it has previously defined as a core inflation rate of 2%. However, the FOMC is currently undergoing a strategic review of this target to asses whether the 2% figure should be an average rate rather than the current policy of it being a hard number. This would mean that because inflation has run below 2% for quite some time (see chart below), the Fed would let inflation run above 2% without adjusting policy, so that the average would be 2%.
Such a shift would be designed to increase inflation expectations and reflects “the need to incorporate the realities of what you could call the new normal into our policy framework,” Fed Chair Powell said. For the bond market, this would likely mean a steeper yield curve as short-term rates would essentially be pegged at current levels, and if the Fed succeeds in driving inflation and inflation expectations higher, an increase in long-term rates. For the economy, this added dose of monetary accommodation could prolong the current expansion and postpone the next recession.
So, while much of the country will be turning a closer eye to the presidential election this summer, the market will also be watching this development as a decision is expected mid-year.
Source: Federal Reserve