Publications /
Opinion

Back
A Possible Tug-of-war Between the Fed and the Markets
March 25, 2021

The projections for United States GDP released by the Federal Reserve on March 17, pointed to a growth rate of 6.5% in 2021, well above December’s 4.2% forecast. Congressional approval of the Biden administration’s $1.9 trillion fiscal package and the vaccination march against COVID-19 explain the rise in the estimate. However, it should not be forgotten that growth in 2021 will follow a fall in GDP of 3.5% last year.

While the expected unemployment rate at the end of 2021 is now 4.5%, instead of the previous 5% projection, the median inflation rate measured by its core (price index of personal consumption expenditure, PCE) expected by members of the Fed’s monetary policy committee rose to 2.2%, above the December 1.8% forecast, but only slightly higher than the 2% on average that now serves as a target under the Fed's new monetary policy framework announced in 2020 (Table 1).

 

Table 1: Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under assumptions of projected appropriate monetary policy, March 2021

Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under assumptions of projected appropriate monetary policy, March 2021

Source: Federal Reserve (2021), Summary of Economic Projections, March 17.

 

For that reason, the opinions of participants in the Federal Open Market Committee (FOMC) meeting on how long the current basic interest rate (between zero and 0.25%) will remain were spread between 2022 and until 2024. At the press conference after the committee meeting, given by its president, Jerome Powell, the signal of a continuity in the immediate future of the accommodative policy approach was reinforced, including a continuation of the Fed’s purchases of Treasury bills.

It should be taken into account that the impact of the Biden fiscal package is what analysts call a ‘sugar rush’, or a short-term burst of energy. A second infrastructure package is planned, but the effect of the tax package now approved will be a one-shot stimulus, instead of creating lasting demand in the economy. Not surprisingly, on average, committee members said they expected core inflation to be 2% in 2022 and 2.1% in 2023.

What about the yields on long-term US Treasury bonds? They fell slightly after the projections were released on March 17, but there is evidence that volatility will continue.

There appears to be a double divergence between the market and the Fed. The inflation projections embedded in bond prices remain above those presented by the Fed. In addition, there appears to be a discrepancy between the mode of action announced by the Fed and what the markets predict as the Fed’s ‘reaction function’.

There is also some discomfort on the part of investors because anticipating movements in basic interest rates became more complicated after the Fed stopped using 2% as a kind of ceiling and the rate became an average. How much and for how long would inflation above 2% become a trigger for tightening monetary policy?

Anyone following Fed officials' pronouncements may have noticed the presence of deep-seated doubts over the past few years. What is the degree of flattening of the Phillips Curve? In other words, how long can the economy stay warm without full employment of labor? What exactly does such full employment correspond to?

In an article for Bloomberg, Jerome Powell referred to unemployment in the Black population, increases in wages in the low-income brackets, and workers with no college education. As in other parts of the world, there is a call for central banks to look at broader sets of indicators than isolated inflation indices as a sole benchmark for economic and financial stabilization. The straight use of aggregate projections for unemployment and inflation has proved tricky, as the world seems to have become too complicated to fit simple rules regarding such variables.

In New Zealand, a pioneer in formalizing the inflation-targeting regime, real estate prices are now included. Let us remember the fever that followed the 2008 global financial crisis about the possible expansion of the range of monetary policy, in combination with prudential regulation, to also keep an eye on the prices of financial assets, instead of simply focusing on prices of goods and services.

Will there be a tug of war between the Fed and the Treasury's long-term bond markets? The 10-year rise in market yields this year has been more pronounced than in previous times of instability, such as the 2013 taper tantrum and the sell-off of government bonds in 2003 and 2015 (Figure 1). Demand for US Treasury bonds has reduced since the beginning of the year, judging by auction prices, suggesting to some that “bond vigilantes” are policing and punishing fiscal policy considered too loose.

 

Figure 1 – Unprecedent spike in 10-year US Treasury bond yields

Unprecedent spike in 10-year US Treasury bond yields

Note: 100 = start of bond sell-off, trading days since start of the sell-off

Source: Ortlieb, P. (2021), Fed can crush ‘bond vigilantes’ if it chooses, OMFIF, March 17.

 

The Fed announced Friday that it will not extend beyond March 31 the easing of banks’ minimum capital rules, which was granted in April 2020 during the financial shock of the start of the pandemic. The permission to temporarily exclude bank reserves of Treasury bills and deposits with the Fed from bank assets requiring coverage in terms of minimum capital will cease to apply.

What about the discrepancy between the Fed's narrative and long-term market yields? How proactive will the Fed have to be in convincing markets? At the Fed meeting in June 2020, the possibility of “controlling the yield curve” was ruled out because it was “not clear that the committee would need to reinforce its forward guidance” with the adoption of such a policy. The Fed's current complacency in relation to long yields can always be superseded by a revision of such a position for the sake of stabilization, if volatility increases in the long part of the yield curve.

 

The opinions expressed in this article belong to the author.

 

RELATED CONTENT

  • Authors
    Françoise Nicolas
    January 24, 2020
    Les relations économiques entre la Corée et l’Afrique ont commencé à se développer à compter de 2006, année qui a marqué un tournant avec le lancement de l’année de l’amitié avec l’Afrique et l’Initiative coréenne pour le développement de l’Afrique. Aujourd’hui, bien que les flux d’aide coréenne à destination de l’Afrique soient en constante augmentation celle-ci reste un partenaire économique de second rang pour Séoul. Ni le commerce, ni les investissements directs étrangers (IDE) ...
  • Authors
    Pierre Jacquemot
    December 26, 2019
    Depuis 2000, selon une approche et un calendrier qui ont été maintes fois modifiés, les 15 membres de la Communauté Économique des États de l’Afrique de l’Ouest (CEDEAO) ont exprimé leur volonté d’accélérer le processus d’intégration monétaire dans la région. Le récent débat autour de la Zone franc et sa réforme, désormais décidée avec la France, mais également l’enthousiasme manifesté autour de la création de la Zone de libre-échange continentale (ZLEAf) formellement créée le 30 ma ...
  • December 19, 2019
    Emerging market and developing economies: Engine of the global economic growth despite some vulnerabilities1 After a long spell of slow growth post-crisis, the global economy’s recovery was mainly supported by the improvement of emerging markets and developing economies growth. However, this recovery is subject to wide-ranging uncertainties and is now in some danger. According to the IMF, the global economic growth is expected to fall to 3 % in 2019, the lowest level since 2008. Th ...
  • Authors
    Numéro spécial du cahier du plan - Volume 2
    December 18, 2019
    Lors du colloque autour du thème « Croissance économique au Maroc : théories, évidences et leçons des expériences récentes », organisé conjointement par le Haut-Commissariat au Plan (HCP) et le Policy Center for the New South et accueilli par le HCP en mai 2017 dans ses locaux à Rabat, des experts et praticiens de près de 30 institutions académiques et non académiques ont échangé et débattu de la croissance économique au Maroc dans un framework transverse alliant le théorique au pra ...
  • December 17, 2019
    L’Inde est confrontée, aujourd’hui, à plusieurs défis énergétiques : - Assurer la sécurité énergétique du pays, en généralisant l’accès pour tous à l’électricité. Ce qui n’est pas le cas en 2019. - Le faire en réduisant sa dépendance aux énergies fossiles, afin de mieux répondre aux orientations des Conférences des parties, COP 21 et COP 22. Pour cela, les autorités gouvernementales vont mener, dès 1981, une réflexion sur les énergies renouvelables, les conduisant à privilégier l ...
  • Authors
    December 2, 2019
    Following the global financial crisis of 2007-08, the International Monetary Fund (IMF) went through a period of self-examination. The old joke that its acronym stood for “It’s Mostly Fiscal” bothered some of its leaders, who believed the organization needed to focus less on austerity and more thoroughly consider issues such as inequality, poverty reduction and gender equality when making loans and other key decisions. There was talk of a “new IMF” that had learned from its old mist ...
  • Authors
    November 22, 2019
    Le rêve d’un monde en développement qui voit ses inégalités se réduire, la condition de vie de ses populations s’améliorer significativement, tout en profitant du bonheur procuré par une population jeune, reste à portée de main. Les macro-économistes ne diront certainement pas le contraire quand on soutient que la plus grande invention de Robert Mundell a sans doute été l’idée du triangle d’incompatibilité. Le concept de Mundell consiste en l’impossibilité de voir coexister de faço ...
  • November 13, 2019
    La décennie 2009-2019 a vu se développer les crypto-monnaies. Ce que certains appellent des unités de compte cryptées. Cette étude est consacrée à deux d’entre elles : le Bitcoin, créé en 2009, et la Libra, dont les premières devraient apparaître en 2020. Deux crypto-monnaies qui peuvent s’opposer ou se compléter. Unité de compte reconnue, le Bitcoin va vite apparaître aussi spéculatif, l’éloignant du caractère monétaire que certains veulent lui attribuer. A l’inverse, la Libra, mon ...
  • Authors
    October 28, 2019
    Global GDP has slowed sharply, from near 4% in late 2017 to half that rate on an annualized basis in recent quarters. The downturn in fortunes over the last two years has come as a big surprise. The rapid expansion of 2016/2017 was broad based but died young. Prior to it we had suffered seven long years of slow growth in the wake of the global financial crisis Why did such a sharp and steady slowdown occur against a background of loose monetary policy, supportive fiscal policy, low ...
  • Authors
    Under the Supervision of
    October 2, 2019
    Africa is an economic region which holds great potential despite the risks associated with its development. Indeed, many experts agree that Africa is emerging as the new frontier for global growth. Boosted by its abundant natural resources, a young and vibrant population, strong urbanization, more stable macroeconomic conditions, more stringent economic policies, a constantly improving business climate and improving governance, Africa is on track for a structural transformation that ...