The Fed stays very dovish

• Overnight, the Federal Reserve kept its fed funds interest rate at 0.00-0.25% and its forceful pace of quantitative easing unchanged at USD120 billion a month of bond buying.
• The Fed also reiterated its large-scale stimulus would remain for ‘some time’ and it would not taper its asset purchases until the economy has made ‘substantial further progress.’
• The Fed did upgrade its view on the US recovery but still saw inflation rises this year as the economy reopens being only temporary.
• We think the Fed will only taper its bond buying from early 2022 and delay raising its fed funds rate until 2024, keeping the outlook favourable for risk assets and bearish for the USD.

Overnight, the Federal Reserve maintained its very dovish stance. The Federal Open Market Committee (FOMC) kept its fed funds rate at rock bottom levels of 0.00-0.25% and left its forceful pace of quantitative easing unchanged at USD120 billion a month of bond buying.

The central bank also reiterated its forward guidance that the fed funds rate would stay at current levels for an extended period until the economy has recovered from the pandemic and reached the Fed’s goals of maximum employment and an average 2% inflation rate.

‘The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.’

Similarly, the Fed wanted to see substantial further progress in the US economy’s recovery before it would start tapering its bond buying.

‘The Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made …’

The FOMC did upgrade its view on the recovery noting that ‘amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened.’

But the Fed continues to see inflation rises this year being only temporary. Chairman Powell said: ‘during this time of reopening, we are likely to see some upward pressure on prices … those pressures are likely to be temporary as they're associated with the reopening process. An episode of one-time price increases … is not likely to lead to persistently year over year inflation into the future, inflation at levels that are not consistent of our goal of 2% inflation over time.’

We think the Fed will stay very dovish this year and refrain from tapering its bond buying until early 2022. When asked about whether it was time to talk about tapering, Powell said: ‘no, it is not time yet. We've said we would let the public know when it is time to have that conversation. We said we would do that well in advance to the decision of tapering. In the mean-time we'll monitor progress toward our goals … it will take some time before we see substantial further progress.’

We also expect the Fed will delay raising interest rates until 2024 after core inflation has averaged 2% over 2022 and 2023. This will favour risk assets at the expense of the USD. We thus see the EUR and CNY rising to 1.25 and 6.15 over the next year while 10Y US Treasury yields only reach 1.90%.

This article was first published by Bank of Singapore on April 29, 2021. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.

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