Fed Declines to Raise Interest Rates Even As Economy Grows

Noting that the US economic recovery remains uneven and incomplete, the Federal Reserve declined to raise interest rates Wednesday. For the time being, it will retain its easy money policy in place even as it acknowledged the economy is starting to roar.

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Fed Declined To Raise Interest Rates

In an expected move, the central bank kept interest rates to near-zero levels even as it continued its monthly $120 billion bond purchases.

This move aims to support the US economy as it tries to get back on its feet. In fairness, the moves are paying off. 2021 started well for the market and is gaining momentum. Increased availability of vaccines and the easing up of individual states contributed to the more optimistic reopening. 

Federal Reserve officials led by chairman Jerome Powell acknowledged that the US economy is growing stronger and that inflation is on the rise. However, they remain in a wait-and-see mode for recovery to become sustainable.

For the moment, the Fed unanimously decided not to raise interest rates.  At the same time, Powell and the company did not give any indication on when they plan to raise the rates. 

‘Uneven and Far From Complete’

Powell noted that the US recovery remains “uneven and far from complete” as he foresees inflation rising in the next few months. He did say that these “one-time increases in prices are likely to only have transitory effects on inflation.”

The Fed chairman said that now is not the time to talk about reducing policy accommodation. This includes discussions about asset purchases.

“It will take some time before we see substantial further progress,” he said. Powell’s group of Fed officials, known as the Federal Open Market Committee, used “substantial further progress” repeatedly in their post-meeting statement.

Stocks Tumble Down After Fed Announcement

Despite a more accommodating tone, stocks tumbled upon hearing the Fed’s post-meeting news conference.  when he addressed the topic of financial stability. He noted that when some measure stability, “they look at some of the things that are going on in the equity markets, which I think do reflect froth.”

The FOMC also noted that government efforts to combat the Covid-19 pandemic helped boost the economy. However, they think the US needs to do more to win the battle. “Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened,” the committee said.

Economic Progress Depends On The Pandemic

“The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors.

Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses,” the FOMC added. The continuation of economic progress now depends largely on how the pandemic fares. 

“The ongoing public health crisis continues to weigh on the economy, and risks to the economic outlook remain,” the statement said. Notable is the absence of the word “employment” in the Fed’s statement. While March showed the word, which denoted a jobs crisis, April did not feature employment as a problem. This indicates that officials see improvement in the labor market.

Best Full Year Since 1984

The Fed’s decision to not raise interest rates comes a day before the Commerce Department releases its preliminary first-quarter GDP figures. The US is projecting a gain of 6.5%, which most experts saw can continue and give the US its best full year since at least 1984.

Rising government bond yields, which indicate higher inflation expectations, jolted stocks in March, but they’ve held steady since.

With the recovery comes inflation. March consumer prices showed a rise of 2.6% for the fastest year-over-year increase since August 2018. Markets are currently pricing at a 5-year inflation rate of around 2.5%.

In contrast, the rates are less than 0.8% last year. Meanwhile, Goldman Sachs’ latest inflation forecast sees it remaining around Fed target levels of 2.2% until 2024 at the earliest. This rate, when viewed through the core personal consumption expenditures price index, can run at 2.05% at the end of 2021, then 2%, 2.1%, and 2.2% each year through 2024, respectively. 

Inflation’s Effects

Already, multiple companies reported that rising cost pressures and their need to hike prices. Procter & Gamble and Kimberley Clark already announced their intention to raise prices on some feminine and cleaning products. Meanwhile, other companies pledged to absorb external cost pressures rather than pass it on to consumers. 

“The market doesn’t like uncertainty. We’ve got uncertainty around corporate taxes, we’ve got uncertainty around interest rates, we do have uncertainty around supply chain disruptions and cost inflation,” said Rebecca Corbin, CEO of Corbin Advisors.

“Companies are good at managing through that. They’ve already put into place mitigation strategies, and everyone is contending with that,” she said.

However, Fed officials insist any pressure on prices is likely temporary and will ease after supply chain issues subside.  As such, the central will allow inflation to run higher than its traditional 2% goal while it chases full and inclusive employment.

Watch the CNBC TV video reporting on Federal chair Jerome Powell: One-time price increases not likely to lead to persistent inflation:

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Do you agree with the Fed’s decision not to raise interest rates even as the economy starts heating up? Do you foresee any problems with this decision?

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