March 22, 2021
Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.
The FOMC is a very powerful force in the markets, and when the Chair of the FOMC speaks, people listen, markets react, and analysts everywhere hang on to every word and adjust their forecasts accordingly. With that in mind, today I’ll highlight some of the main points that were brought up in Fed Chair Jerome Powell’s hour-plus long press conference that was held last week following the FOMC’s 2-day meeting and explain some basic takeaways.
The FOMC statement can be found on their website (link here). All bolded quotes below are from Fed Chair Jerome Powell’s press conference on 3/17/21.
“At the Fed, we will continue to provide the economy the support that it needs for as long as it takes.”
As has been the message from the FOMC since the start of the pandemic, they are willing to do whatever it takes, for as long as it takes. They are in this for the long-haul and will do whatever they have to do to keep the markets functioning smoothly, help us return to maximum employment, and achieve their inflation targets.
“Forecasts from FOMC participants for economic growth this year have been revised up notably since our December summary of economic projections.”
As many people do, the FOMC feels better about the future of our economy in the near and intermediate term than they did in December. Many signs and economic indicators over the past three months point to a stronger and faster rebound than many were expecting. This is a result of many factors, including the pace of the vaccine rollout and Democrats winning both Georgia Senate runoff elections meaning that a new and larger stimulus package would be easier to get passed and be able to stimulate the economy sooner and more forcefully.
“For the economy as a whole, employment is 9.5 million below its pre-pandemic level … [The unemployment rate] understates the shortfall in employment, particularly as participation in the labor market remains notably below pre-pandemic levels.”
Although numbers are trending in the right direction, we are not out of the woods yet. The economy still has a long way to go to get back to pre-COVID levels of employment. The standard metric of the unemployment rate might be a little deceiving, as it does not take into account people who have dropped out of the labor market or are under-employed.
“Over the next few months, 12-month measures of inflation will move up … However, these one-time increases in prices are likely to have only transient effects on inflation. The median inflation projection of FOMC participants is 2.4% this year and declines to 2% next year …”
“That’ll be a fairly significant pop in inflation. It’ll wear off quickly though … you’re seeing this now, particularly in the goods economy, there’ll be bottlenecks. They won’t be able to service all of the demand, maybe for a period… But those are not permanent things … so it’ll turn out to be a one-time sort of bulge in prices, but it won’t change inflation going forward”
We will probably see a fairly significant spike in inflation over the next few months, but this is likely to be temporary. Year-over-year inflation will move higher due to the extraordinary and unprecedented ground we have covered over the past 12 months along with temporary effects coming into play this year. The $1.9 trillion stimulus package will stimulate the economy and put money in people’s pockets to spend, but the $1,400 checks are not a monthly or annual payout, they are a one-time thing. The spending that they encourage will be short-lived and 1-2 years down the road their effect on demand will likely have disappeared. The pent-up demand will similarly have a short-term effect. Just because you couldn’t take a vacation in 2020 doesn’t mean you are going to take double the vacations for the next 10 years … you might take an extra vacation in 2021 or 2022, but it will likely not change your long-term vacation habits. He also mentions supply-chain bottlenecks that could lead to temporary inflation, but these will not cause a permanent increase in prices, clearing themselves as the global economy slowly returns back to normal. After these temporary effects run their course over the next year, inflation is expected to come back down.
“What I’m telling you is that the stance of monetary policy we have today, we believe is appropriate.”
This was in response to being asked about whether they are considering using other tools in their toolbox, such as adjusting the levels or make-up of their asset purchases in order to influence yields across the yield curve. Chair Powell’s response makes it clear that they feel their current policy stance is appropriate and they are not actively considering altering their asset purchases (currently $80 billion/month of Treasuries and $40 billion/month in mortgage-backed bonds) to try and influence the yield curve. For example, if the FOMC thought that the 10-year Treasury yield was getting to high and making financial conditions prohibitive to economic growth, they could choose to purchase more 10-year Treasuries than they currently are in an attempt to drive the yield lower. It is important to keep in context the yield levels we are seeing. While Treasury yields have risen fairly swiftly since the beginning of the year, in the bigger picture, a 1.75% 10-year Treasury is still very low from a historical perspective and it is hard to argue that such a historically low yield is inhibiting economic growth. I would assume that this is what the FOMC is thinking and why they are not currently considering using their influence to try to bring down yields on the longer parts of the curve.
March 17 Summary of Economic Projections:
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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