Expectations for major changes at the Federal Reserve (Fed) September meeting were low. The Fed had completed its framework review at the annual central bank symposium at Jackson Hole, Wyoming, in late August when it announced its shift toward flexible average inflation targeting. While no major policy decisions were made at the September meeting, the Fed did alter the language of its guidance to align with the change in inflation targeting, allowing for potentially higher inflation before it would consider raising rates. Chairman Powell confirmed the guidance in his recent testimony before Congress. The Fed “dot plot,” a graphical projection of when Fed members expect to see higher rates, shows that voting members expect rates to remain at the zero-bound until at least 2023. The Fed also continues to express concern for downside risks to the economy.
Although the Fed has reiterated that negative policy rates seen in Europe and Japan are not under consideration, adjustments to the policy rate are only one mechanism for further easing of financial conditions. The Fed also can provide additional support through adjustments to its asset purchase programs or changes to other available liquidity facilities. However, the current stance may leave the Fed vulnerable to being surprised by a better-than-expected recovery, which may have longer-term implications on inflationary forces.
The European Central Bank (ECB) chose to leave its policy rate unchanged and not to revise its primary COVID-19 relief package, the Pandemic Emergency Purchase Programme (PEPP). The decision to stay put was largely expected by market participants, as growth in the Eurozone has been somewhat better than projected. The ECB noted that downside risks prevail, as concerns over rising COVID-19 cases in Eurozone countries have tapered the sharp rebound earlier in the summer—particularly in the services sector—while also keeping a lid on consumer confidence.
One of the primary macro themes since the outbreak of COVID-19 has been the weakness in the US dollar. The dollar weakness against the euro, a primary focus of the ECB at its September meeting, has recently reversed. While ECB President Christine Lagarde emphasized that the bank does not have an exchange-rate target, she did note how appreciation of the euro could put downward pressure on inflation expectations and potentially trigger additional policy accommodation. Relative to the Fed, the ECB has not grown its balance sheet to the same degree during the current crisis and may leverage this mechanism to limit the effects should the euro appreciate.
The Bank of Japan (BOJ) wrapped up its monetary policy meeting by retaining its current policy stance to keep its key interest rate at -0.1% and left the yield target and asset purchases unchanged, widely in line with market expectations. Following the resignation of Japanese Prime Minister Shinzo Abe, BOJ President Haruhiko Kuroda vowed to coordinate closely with the government of new Prime Minister Yoshihide Suga.
Like the Fed and ECB, the BOJ has seen economic conditions develop better than expected, but it has continued to note the downside risks presented by the ongoing pandemic. While economic conditions have picked up, the BOJ reiterated its support for fiscal expansion through the absorption of new Japanese Government Bonds, putting quantitative easing and yield curve control at the center of its monetary policy.
Monetary policy decisions that were previously considered unconventional following the 2008 financial crisis have become widely adopted. After the massive deflationary shock that characterized the initial months of the pandemic, central banks have clearly shifted their focus toward boosting inflation and maintaining accommodative guidance.
While vocal critics of the new monetary policy regime warn about the risks of hyperinflation, we remain in a slightly deflationary environment. Ballooning central bank balance sheets will slow global growth in coming years. The recent performance of long-dated Treasury maturities has been exceptional. Should the economic recovery falter for any reason, there is still room for rates to decline to international levels. However, positioning around some inflation, particularly if the dollar weakens, may still be beneficial.
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