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Fed stays put on rates but dot plots rise

United States federal reserve system signature stamp.

The U.S. Federal Reserve (Fed) this week announced it will stay the course on its historically dovish approach to monetary policy – at least for now. The target for federal funds rate remains at 0-to-0.25% with no plans to change until full employment is reached and inflation sustainably exceeds the Fed’s 2% target. Asset purchases were also not tapered and will stay firmly in place at US$80 billion a month in treasury securities and US$40 billion in mortgage-backed securities.

Risks remain

Wednesday’s announcement struck a hopeful note – vaccinations have progressed quickly, and the spread of COVID-19 continues to abate throughout the U.S. Nonetheless, some clouds remain as the Fed cautioned that more improvement is needed in some pandemic-weakened sectors and the U.S. economy remains tied to the path of the global and domestic economic reopening.

Inflation not a concern

Rising short-term inflation, however, is not a cause for concern at this time. In his post-announcement speech, Fed Chair, Jerome Powell, sounded easy and unconcerned about inflation, and he underscored the effects of temporary supply bottlenecks in sectors like used cars and the impact of gasoline prices on the cost of energy for consumers.

For the moment at least, the U.S. is experiencing a historic post-pandemic bounce back – consumer spending, housing and business investment are all on the rise and the Fed now projects 7% GDP growth for this year, up from its prior projection of 6.5%. Looking further out, growth projections for 2022 and 2023 are for 3.3% and 2.4% respectively.

Talking about talking about tapering

But Powell’s comments on anticipated interest rate increases did cause some ripples. He indicated that the Fed’s employment and inflation targets could be met by 2023, much sooner than anticipated. Take these comments with a grain of salt, it really is talking about talking about tapering. As of now, there are no firm plans to begin shifting from the Fed’s accommodative monetary stance. However medium-term expectations among committee members are starting to turn hawkish. Seven of the 18 FOMC participants anticipate a rate hike in 2022, and 13 members expect at least one rate hike before the end of 2023.

Powell’s post-announcement remarks remained very easy, however, his lack of clarity around the rising dot plots did fail to completely unwind the market’s initially negative reaction to the rising medium-term interest rate expectations.

Positioned appropriately

Our portfolios continue to be positioned with an overweight allocation to equities, however we have trended that overweight down modestly over the past couple months. Risk assets remain well supported by strong financial conditions and are expected to outperform.

From a fixed income perspective, we are modestly short duration with a continued expectation that the middle of the yield curve across developed market economies will gradually increase to moderately higher rates. We saw this materialize somewhat following the announcement with the yield for 5-year bonds increase by 0.1%.

If you have any questions or require more information, please contact your MD Advisor*.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

About the Author

Richard Schmidt, CFA, is an Associate Portfolio Manager with the Multi-Asset Management Team of 1832 Asset Management L.P. His primary focus is MD’s North American equity funds and pools.

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