The Fed's Next Steps

This week’s meeting of the Federal Open Market Committee (FOMC) gave further evidence of recovery: In its quarterly Summary of Economic Projections (SEP), the “dot plot” outlook showed that a majority of Fed governors expect a higher federal funds rate by 2023. In March, the median called for unchanged rates until at least 2024. While the direction of the change is logical (few would argue that the policy rate should stay near zero in perpetuity), a documented timeline makes the shift feel tangible.

With the possibility rising of a change in policy, the Fed will face greater scrutiny in its decision-making. Its responses to the COVID-19 crisis were swift, helpful, and applauded by investors. It now faces the challenge of pulling back a bit without upsetting markets.

Inflation and employment metrics are both in perplexing states that may complicate the Fed’s upcoming decisions. Much ink has been spilled on the topic of inflation, including our own recent commentaries (here and here). In his post-meeting press conference, Fed Chair Jerome Powell reiterated his view that temporary bottlenecks were responsible for the bulk of recent jumps in prices, and the FOMC would appear to agree. The SEP inflation forecast for 2022 rose, but expectations for 2023 did not change much. That said, a majority of FOMC participants indicated inflation risk is to the upside.

The Fed is a lightning rod for inflation concerns, as it has a mandate to maintain stable prices. Some have called for immediate reductions in asset purchases to head off problems later on. However, much of the current attention is misplaced. The Fed has no tools or remit to advance vaccines, bolster semiconductor supply chains or control the prices of used cars. Changing course to battle inflation that proves fleeting could unsettle markets and put the booming recovery at premature risk.

Excessive focus on inflation also takes attention away from the other side of the Fed’s dual mandate: maximum employment. While they have not set an explicit target, Powell and other Fed governors have expressed the desire to recreate the strong and inclusive state of the labor market through 2019, when the unemployment rate held at 3.5% and job growth and wage gains accrued to workers across races and income levels. With current unemployment of 5.8% and labor force participation still well down from its pre-pandemic standing, the labor market has a lot of ground to retrace.