With the benefit of hindsight, today marks the one-year anniversary since the US equity market bottomed during the start of the pandemic crisis. Following an unprecedented market sell-off and a surge in volatility, the US equity markets fully recovered to pre-pandemic levels in just five months and are up 75% from the March 2020 lows. US treasury yields have also reached the highest level since the start of the pandemic, pricing in higher inflation on the back of a stronger economy. Last week’s US Federal Reserve FOMC meeting, therefore, served as a window of opportunity to reassess the monetary policy outlook at a time when the recovery is strengthening and stimulus remains accommodative.

The buoyant equity market highly contrasts with the economic reality over the past year. With equity markets forward looking in nature, the accommodative policies and the discovery of several effective covid-19 vaccines towards the end of last year strengthened the economic outlook and fuelled the rally.

Since then, investors’ concerns for the US have shifted to potential monetary policy tapering. Rather than focusing on the economic impact of the covid-19 pandemic on earnings potential, investors now fear that the relatively faster vaccine rollout and the additional $1.9 trillion stimulus will overheat an economy that already shows signs of improving. This would force the Fed to increase interest rates quicker.

Nevertheless, last week’s meeting reaffirmed the Fed’s dovish message and provided further insight to the expected monetary policy outlook. Despite the improving forecasts for a post pandemic world, monetary policy remained unchanged, with interest rates near zero and continued asset purchases. However, the FOMC acknowledged the improvement in outlook for the year 2021 by upgrading the expected change in US real GDP, from the December projection of 4.2% to the current projection of 6.5%. In addition, unemployment rate is forecasted to fall to 4.5% and core inflation is expected to reach 2.2%.

One of the key takeaways from last week’s FOMC meeting was the Fed’s tolerance for transitory rise in inflationary pressures. In line with the Average Inflation Target policy framework, Fed Chair Jerome Powell underscored the three main conditions required to trigger a change in monetary policy: that labour market conditions are consistent with full employment and that inflation is above the 2% level and on track to exceed the 2% target moderately for some time.

While inflation for 2021 is forecasted to exceed the 2% long-term goal, the FOMC expects this upward move to be a transitory, and which will normalise as the economy reopens. Fed Chair Powell also shared the need for substantial further progress before the FOMC implements changes to the bond-buying program. Upon further explanation, the Fed is looking for actual rather than forecasted progress towards achieving the three aforementioned conditions, and guided that this will take some time to achieve.

More interestingly, the FOMC has also incorporate the view of a broad and more inclusive maximum employment goal, assessed on a wide range of indicators. Economic crisis tend to create further disparities, with the impact felt unequally among different backgrounds and income levels. This implies that the FOMC will gauge the progress towards full employment on a broader range of metrics than the unemployment number alone. Case in point, the participation rate, which stands below pre-pandemic levels. Furthermore, the inclusion of employment numbers across demographic groups that are slower to recover, may further slow the pace at which the Federal Reserve decides to increase interest rates.


This article was written by Rachel Meilak, CFA, Equity Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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