Fed revise up US outlook, interest rates stay at zero until 2023

September was also the first monetary policy meeting since the Fed announced its new average inflation targeting framework. Market response was mixed as some investors doubted the Fed’s ability to return inflation to target.

A smaller downturn in 2020
The US economy has seen a faster than expected resumption of economic activity since the ‘stay at home’ orders ended in May. Most notable has been the improvement in the labour market. The number of people who lost their jobs in March and April was 22 million, but since then an astonishing 11 million (nearly 50%) have returned to work. The unemployment rate has fallen to 8.4% in August, from its April high of 14.7%. Other indicators of economic activity have been positive too, including retail sales and housing market activity.

These developments have led the Fed to reduce the projected depth of the recession in 2020 to 3.5%, from the 6.5% contraction projected in June. The range of forecasts – which varies across FOMC members is also much narrower now (Figure 1). The unemployment projection has also been lowered to reach 7.5% in 2020 down from their earlier estimate of 9.3%.

Fed struggles to return inflation to 2%
This was the first meeting since the Fed has announced its move to a new average inflation targeting framework at Jackson Hole. Powell delivered “strong and powerful” forward guidance that interest rates would remain at current lows of 0-0.25% until 2023.

It is surprising that such rock bottom interest rates and continued purchase of agency and mortgage backed securities (QE) were insufficient to push inflation above 2% before 2023. The Fed’s own projections show inflation reaching 2% in 2023. Some interpreted this as a struggle to return inflation to target. Powell denied that the Fed had run out of monetary firepower. The spectre of Japan (low growth and deflation/low inflation) loomed high on the minds of sceptics.