This Week’s Fed Meeting May See A Third Major Change To Its Dollar Strategy

And China arrived and defeated the Fed

Monex Europe | Jerome Powell’s speech at the virtual Federal Reserve symposium this year made it clear that monetary policy in the US was moving to a structurally more dovish reaction function. The Fed Chair outlined historic changes in a new Statement on Longer-Run Goals and Policy Strategy. Powell announced a switch to average inflation targeting, and a move away from pre-emptive rate hikes as the economy approached estimates of maximum employment. Both of these changes add up to a significantly more dovish Fed, and the dollar has duly remained on the back foot since. The Fed’s ongoing framework review now appears to have been concluded, clearing the way for changes to nearer-term forward guidance issues as part of regular policy statements.

This week’s Fed meeting may therefore see a third major change to the Fed’s policy, and one with more immediate implications for the dollar and US markets, in the form of outcome-based forward guidance:

  • Recent meeting minutes and speeches have made it clear the FOMC is considering a range of possible calendar and outcome-based forward guidance. The likeliest outcome is further formalisation of the Fed’s shift away from viewing maximum employment as a constraint that will lead to rate hikes. Powell’s speech may provide a template for what outcome based guidance could look like. In his speech, the Chair stated “employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation”. In practice, the Fed could link changes in policy to a robust, sustained convergence of inflation to a level that would threaten even the Fed’s looser average inflation target.
  • Further details of how average inflation targeting will be implemented would be nice, but are unlikely to be forthcoming. Some guidance on the length of the averaging period would be particularly interesting, with the Fed’s 3-year forecast horizon the obvious starting point. New member “dot plot” projections will be issued, providing a related insight into members’ opinions. The previous set of projections, from June, showed members’ expectations of rates flat over the forecast horizon, but still relatively unchanged at around 2.5% over the longer run.
  • Asset purchases, which were included in the Fed’s framework review, will also be a topic of interest, although formal changes may not be announced this week. The Fed’s current “whatever it takes” approach to asset purchases gives it great flexibility – this may be changed to a regular monthly pace that is announced ahead of time as the US recovery continues.