The U.S. Federal Reserve keeps its key interest rate on hold, which was widely expected. But the Fed stated that the path of the economy will depend significantly on the course of the virus. Anthony Okolie speaks with James Marple, Senior Economist, TD Bank, about the outlook for rates and the U.S. economy.
- As expected, the Fed left rates unchanged at near zero. And the tone was, again, extremely dovish. Had no plans to raise interest rates until at least 2022. James, what got your attention today?
- Yeah, well this statement did very little to change Fed policy. They left rates unchanged, as you said. What they did change was their assessment of the current economy, and they had to acknowledge that there has been some positive indicators.
We've seen employment bounce back a little bit from where it was at its trough. But as they also acknowledge, it's still a long way from normal. We've seen jobs take about 40% of the jobs that were lost regained so still a long way to go.
And, of course, no material change to their expectation for future policy. And they just acknowledged that so much will depend on the course of the virus itself. Basically saying, their hands are tied.
- And I want to pick up on that. The Fed also said they saw a pickup in economic activity recently. But that growth is still well below pre-pandemic levels. What's your take on that statement?
- Yeah, again, I think they just had to acknowledge that since their last statement in June, we have seen data come in to show that, look, the economy was recovering. They probably don't quite have enough of actual hard economic data to point to a bit of the stalling in that recovery that we have seen in some of these newer high frequency data. Perhaps that's something the Fed chair will address in his press conference.
But I think tying the economic outlook to the health outcomes kind of makes that implicit. What we are seeing is that as cases have increased, we've seen spending levels start to taper off. And I think the Fed is implicitly acknowledging that by tying the economic outlook to the health outcome.
- OK, I want to switch gears a little bit. Now the Fed has taken a lot of steps to anchor the yield. What other tools does it have in its toolbox?
- Yeah. That's a very good point. I mean, if you look at the US yield curve, it's extremely flat. The five year rate is in the 20 basis point range. The three month and the two year, both right close to zero. Even out to the 10 year, you don't have very much in the way of positive yield.
So certainly, some of that obviously just reflecting expectations that policy is going to stay accommodative for some time. So the Fed's thinking, what else can we do?
One thing they've talked about is moving to an average inflation target. So we know that inflation has underperformed their 2% target, actually all the way back to 2012. And it's recently with the virus and the shock to the economy, push close to zero. If they wanted inflation to average 2%, actualized inflation in the future would actually have to push higher than that.
If they could convince market participants that they were committed to higher inflation, you'd start to see that show up in inflation expectations and yields. And you get real yields a bit lower. And I'd be curious to see what the Fed chair is going to say about that. But certainly, I think the Fed is moving that way.
Of course, they could also move to something like a yield curve control, stating an explicit target for something like the 10-year yield. But as you said, they've already done such a good job in anchoring yields low, I don't think they really need to do that. And they'd get further traction by moving to something like an average inflation target. And I suspect that is where they will go.
- And we just have a few seconds left, but I want to touch on the US dollar, which has weakened quite a bit recently against a basket of world currencies. What's driving that weakness? And where do you see the dollar going in the next little while?
- Well, I think, it, very much, reflects the fact that while other economies have done a better job of lowering their case count and containing the virus, the US has seen it pop up. And it's seen its economy deteriorate as a result. So we've seen increased confidence in economic recovery elsewhere and a little bit less in the United States, and that's hurt the dollar.
I think, probably, most of that movement has happened now. But, of course, we'll, again, just have to see how things go with containment of the virus. Starting to see some good signs-- very early positive signs there, but it is really hard to predict.
- James, thank you very much for your insights.
- You're welcome.