The focus of this week’s FOMC meeting is how the Fed would respond to the rising Treasury yields and the rapid improvement in the economic conditions. We expect policymakers to upgrade the GDP growth forecasts and attribute rising yields to improvement economic confidence. Yet, the tone should remain cautious. All the monetary policy measures will stay unchanged at the meeting. The Fed will leave the asset purchases at US$120B per month and the Fed funds rate at 0-0.25%. All forward guidance will remain intact.
Economic data since the last meeting suggest that the recovery is underway. The February job report was upbeat, with the nonfarm payrolls jumped +379K, more than doubling the addition in January. This also beat consensus of a +182K. More importantly, the increase mainly came from the private sector as government payrolls actually slipped during the month. The unemployment rate slipped to 6.2% last month. On inflation, headline CPI accelerated to +1.7% y/y in February, from +1.4% a month ago. Core CPI, however, eased slightly to +1.3%, from January’s +1.4%.
Improvement in inflation is unlikely to alter the Fed’s policy. The average inflation targeting suggests that policymakers will allow inflation to rise above the +2% target for some time so as to offset periods of below-target inflation. However, what we are interested in is the Fed’s response to the rising inflation expectations and the resulting increase in Treasury yields. Longer-term inflation expectations have accelerated recently, with the US 10-year breakeven rate rising above 2%. Meanwhile, although the short-dated yields have remained steadily at low levels, the medium- and long-dated ones have picked up significantly since the beginning of the year.
We expect the Fed to look through the recent rise in yields and attribute the phenomenon to better economic developments and stronger market confidence. As Fed Chair Jerome Powell spoke at the Wall Street Journal Jobs Summit earlier this month, he regarded the rise in yields as something “notable”. He added that he was concerned by “disorderly conditions in markets or a persistent tightening in financial conditions that threatens the achievement of our goals”, The Fed “is prepared to use the tools that it has to foster achievement of its goals”, if “conditions do change materially”. However, he reiterated that the economy is still facing “a long way from our goals of maximum employment and inflation averaging 2% over time”. These comments reveal that the Fed will likely take a wait-and-see mode at the March meeting.
Besides the policy statement and press conference, the Fed would release the updated economic projections and the median dot plot. In light of the upbeat economic data during the intermeeting period, approval of the US$ 1.9 trillion fiscal stimulus and encouraging vaccination progress, the Fed will likely upgrade significantly the GDP growth forecast for this year. The unemployment rate will also be revised lower. While the headline inflation could be revised higher, the core reading should stay largely similar to the previous projections. It won’t be surprising to see more members anticipating higher policy rates in 2022 and 2023. However, the changes will unlikely to alter the big picture that no rate hike will be seen until 2024.