US: Much ado about nothing

Fed Chairperson Powell, in his opening speech at the “virtual” gathering of central bank governors yesterday announced that going forward the Fed would “seek to achieve inflation that averages 2% over time” and therefore that “following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.”

He specified that the “Fed was not tying itself to a particular mathematical formula that defines the average”. Underlying this new Fed stance is its subtle but greater emphasis on full employment.

The Fed’s measure of inflation is the Personal Consumption Expenditure (PCE) price index and our understanding is that its preferred metrics is core PCE inflation, which strips out more volatile food and energy prices.

Therefore, our interpretation is that should US core PCE-inflation remain below 2% the Fed would not feel compelled to immediately tighten monetary policy if/when inflation rises above 2%. Put differently the Fed is making explicit its tolerance for inflation over-shoots. All measures of US inflation, including core PCE, were well below 2% in July.

The bottom line is that the Fed policy rate, currently 0-0.25%, is now likely to remain lower for longer, which has only limited implications for the very short-end of the US rates curve, beyond cementing market expectations that a Fed policy rate hike is not on the horizon.

Similarly, we think the Fed’s announcement has limited implications for the Dollar near-term. It weakened sharply today but so far in August is down only 1.1%, in line with our benign Dollar view.

Of more concern for the outlook of the US economy and Dollar, in our view, is the fall in the Conference Board consumer confidence index to a six-year low in August, which we attribute in part to the tempering and even reversal of the easing of lockdown measures.

Our analysis suggests that this points to a further slowdown in household consumption (from an already meagre 1.6% mom in July) and ultimately GDP growth in the month.




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