Fed would have to keep interest rates at zero for more than 3 years

The Fed did not touch interest rates as expected, signaling that it will continue easy monetary policy for a long time, helping the American economy to recover from the coronavirus crisis. (Tera Yatırım)

According to the updated dot plot, 13 of the 17 members do not anticipate an increase in interest rates until 2023, while the Fed will allow inflation to rise slightly above the 2% target in accordance with the new inflation strategy in the monetary expansion process. In this new inflation approach announced by Powell in Jackson Hole, the inflation target of 2% on average has been determined as the new threshold point of the Central Bank.


However, there is also opposition to the decision taken within the board. Decisions were taken by 2 votes to 8 at the September meeting. Dallas Fed Chairman Kaplan opposed the decision, preferring to maintain "more policy rate flexibility"; Minneapolis Fed Chairman Neel Kashkari, on the other hand, said that he would wait for a rate hike "until core inflation reaches 2% continuously". There are better forecasts in the economic forecasts updated compared to June. If we look at them;


·         In GDP, 3.7% contraction in 2020 (6.5% contraction in June), 4% growth is expected in 2021.

·         The unemployment rate is expected to be 7.6% in 2020 (June estimate 9.3%) and 5.5% in 2021.

·         PCE inflation is projected to be 1.2% in 2020 (June forecast 0.8%), and 1.7% in 2021.

·         The federal funds rate is estimated to be 2.5% in the long run.


The Fed seems to have revealed the technical details. The market did not expect much new information either, as the market realized at the Powell speech that once the Fed reached its 2% inflation target, the policy would not be tightened. However, it seems very difficult to feed inflationary pressures from the demand channel. As a result of lack of unemployment benefits and increasing unemployment, the demand effect will diminish after August, the first signs of this being seen. At this point, the ability of Americans to demand goods and services, especially if their income is declining, will not have an impact that can drive inflation up steadily. Here too, the eyes turned to supply channel, at this point there is no mechanism that the Fed can control through monetary policy. The Fed's excessive monetary expansion is likely to overheat inflation. The limitations of what can be done in this regard cause some people to look more favorably on the old school approach, that is, directly targeting 2% inflation.


The economy has emerged from the worst for now and has recovered at some point. However, there are still factors such as epidemic, election uncertainty and financial package uncertainty that can put the economy into an impasse. On the fiscal stimulus package, considering that there were elections at the beginning of November, time is running out and if the two political parties do not agree until then, the package will fall victim to the election noise. The absence of temporary extra unemployment benefits and new incentives will strain the economy after the autumn. The economy is undergoing a transformation with the epidemic, and the increasing weight of automation will cause some Americans to be unable to return to their jobs. The high speed of the epidemic will add to this. More will have to be done in reducing the unemployment rate than was done during the Lehman Brothers period, but even if the unemployment rate to reach full employment will create inflation, this will catch up to the last phase of QE. In other words, when the 2023 unemployment rate of 4% projected in economic projections is reached, the Fed pandemic QE will have completed 3 years. It seems that the interest rates will be close to zero point beyond 2023 with this monetary policy route.


We can call it a meeting that dovish as expected, where the Fed saves the day. It remains uncertain how and in what form inflation will be, how much QE success will be, how the relationship between employment and inflation will be established.


Kaynak Tera Yatırım
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