Interest rates: Lower for longer...or forever?

On September 16, 2020, the U.S. Federal Reserve (Fed) left interest rates near zero and signaled that it expects to hold them there through at least 2023, adding outcome based guidance. The statement follows the new long-term policy framework announced by Chair Jay Powell in August at the Federal Reserve Bank of Kansas City’s annual Jackson Hole conference. The Fed notes that rates will remain near zero “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” We didn’t get a precise definition of what a moderate overshoot would look like, allowing the Fed to retain some flexibility. Officials see inflation getting to 2% by 2023 and unemployment getting down to 4% around that time. 

The Fed also committed to continue buying Treasuries and mortgage-backed securities “at least at the current pace to sustain smooth market functioning.” These purchase amounts are currently $80 billion of Treasuries per month and $40 billion of mortgage-backed securities. Economic forecasts for this year were also upgraded with a lower unemployment rate and smaller GDP contraction than previously expected. 

There were two dissents at the meeting, with Dallas Fed President Robert Kaplan preferring to retain “greater policy rate flexibility” given the quick pace of the recent recovery and Minneapolis Fed President Neel Kashkari wanting to wait for a rate hike until “core inflation has reached 2% on a sustained basis.”

Our take

This announcement is further confirmation that the Fed is prepared to provide whatever support the economy needs including further action should the recovery tail off. This stance includes a willingness to maintain (and potentially increase) asset purchases as well as tolerate above target inflation. While the market reaction was relatively muted, we believe this policy action continues to provide support for equities (in particular U.S. equities) as well as U.S. Investment Grade Corporates over the medium-term. Inflation expectations may also increase modestly as a result of this statement, though we view inflationary and deflationary risks to be roughly balanced and maintain a neutral stance on rates.

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