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4 Key Takeaways from the Fed's July Meeting

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Following July’s Federal Reserve’s FOMC meeting, 4 takeaways are clear: the U.S. economy continues to improve, inflation remains transitory, monetary policy stays accommodative, and Tapering is deferred for a later day when the economy reaches the Fed’s employment and inflation goals.

The U.S. Economy Continues to Improve, but Still Below the Fed’s Targets

“The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals,” says the Fed statement, which was released at 2 p.m. on Wednesday. “With progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen.”

One of these indicators the Fed is referring to is the real Gross Domestic Product (GDP), a measure of the nation’s total output, which grew by an annualized 6.3 percent in the first quarter, following a 4.5 percent and 33.8 percent expansion in the previous two quarters. That’s a big turnaround from the first and second quarters of 2020, when GDP dropped sharply following the outbreak of the COVID-19 pandemic.

Another indicator the Fed follows is the unemployment rate, which stands at 5.9%, well below the 10.2 percent it was standing a year ago, but still above the natural rate. According to Fed estimates, the natural rate stands at around 4 percent. That’s the unemployment rate consistent with the Fed’s maximum employment, or full employment, goal.

In short, the U.S. economy is producing more than it was producing a year ago, which has helped Americans return to work, but it has a long way to go before reaching the Fed’s goal of maximum employment.

Inflation is Transitory

A strong economy has brought back an old villain, inflation. Prices of everyday goods and services have been rising, undermining the buying power of American households. The annual inflation rate in the U.S. accelerated to 5.4% in June of 2021 from 5% in May, reaching a new high not seen since August of 2008, and well above forecasts of 4.9%. 

These figures are well above the Fed’s 2% target. However, the nation’s central bank considers them “transitory.”

“Inflation has risen, largely reflecting transitory factors,” says the Fed. “Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses. The path of the economy continues to depend on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.”

Simply put, the Fed is willing to tolerate inflation numbers above 2% in the short term, redefining its goal of steady inflation to mean average inflation of 2%. “With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well-anchored at 2 percent,” says the Fed.

Thus, the Fed policy remains accommodative, and Tapering is put off for a later day.

Monetary Policy Remains Accommodative, and Tapering is Postponed

“The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved,” says the report. “The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent.” 

Simply put, short-term interest rates, like the prime rate and interest on bank deposits, will continue to stay at ultra-low levels.

What about Tapering, the gradual slow-down in the Fed’s purchase of securities with longer maturity? It’s pushed back to another day, when economic conditions will grow closer to the Fed’s goals.

“In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook,” says the Fed. “The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.”

Meanwhile, the Committee instructs the Open Market Desk at the Federal Reserve Bank of New York to conduct “overnight reverse repurchase agreement operations at an offering rate of 0.05 percent and with a per-counter party limit of $80 billion per day.”

What it Means for Wall Street

The Fed’s accommodative policy has been a significant factor behind Wall Street’s rally in the last sixteen months. Low short-term and long-term interest rates raise investor appetite for risk assets like stocks, high-yield corporate market debt, emerging market debt, and cryptocurrencies.

Furthermore, the continuation of these policies will provide support for such appetite, although valuations are disconnected with fundamentals in specific sectors of the equity and debt markets.

Summary and Conclusions

In its July FOMC meeting, the Fed told Wall Street what it wanted to hear: traditional monetary policy will remain accommodative. However, Tapering will be put off for another day, when the economy reaches the Fed’s goals of maximum employment and steady prices.

When that time will come is everyone’s guess. Meanwhile, those who have been around Wall Street long enough know very well what happens when monetary policy stays accommodative for too long: asset bubbles blow and burst, and some investors lose a great deal of money.

The post 4 Key Takeaways from the Fed's July Meeting appeared first on TipRanks Financial Blog.

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