The Federal Reserve expects the U.S. economy to boom after the COVID-19 pandemic eases this year, but the central bank signaled the strong rebound would not shake its plans to keep short-term interest rates at effectively 0% through 2023.
Fed officials' quarterly forecasts reflected a sunnier outlook following progress on vaccinations and a new $1.9 trillion stimulus package, which the central bank says could lead to a 6.5% spike in GDP this year. That projection was up from an already strong December 2020 forecast of 4.2%.
Markets had been closely watching the Fed's projections for any hints that stronger growth would move up the Fed's plans to gradually remove its support for the economy. But the Federal Open Market Committee's forecasts indicated that most officials agreed with its plans to keep rates ultra-low, a year after the COVID-19 pandemic prompted it to slash interest rates to near zero.
A full recovery from the pandemic is likely to take some time, and the Fed is committed to sticking with its "patiently accommodative stance until the job is well and truly done," Fed Chairman Jerome Powell told reporters after the central bank's March 16-17 meeting.
"We'd love to see it come sooner rather than later. We'd welcome nothing more than that. But realistically, given the numbers, it's going to take some time," Powell said.
The FOMC made no notable changes to its policy, keeping the benchmark federal funds rate at effectively 0% and sticking with its plans to continue a $120-billion-per-month bond purchase program. Its statement noted that economic activity and employment data have "turned up recently," but the sectors that the pandemic hit hardest "remain weak" and that the outlook will depend on the course of the virus and vaccinations.
Powell has been consistent with his messaging that the Fed will keep rates on hold until it reaches its goals, even if the market "doesn't want to hear it or doesn't want to believe it," said Jack Janasiewicz, portfolio manager at Natixis Investment Managers.
Fed officials' individual forecasts did suggest some disagreement at the Fed about whether it should stay on hold through 2023, with seven of the 18 FOMC members penciling in at least one hike by 2023. Four Fed officials also believe at least one hike may be necessary in 2022.
Asked about the issue, Powell said the faster-projected tightening among a few officials is not surprising given the large upgrades in economic projections. But the bulk of the committee did not see a rate increase as necessary during the forecast period, he noted.
Part of that is because Fed officials are emphasizing the need to see actual data improvements to shift their views on policy, rather than responding to forecasts of strengthening, Powell said.
The Fed's forecasts show officials expect some quick improvements toward their goals of maximum employment and inflation stabilizing around 2%. But the Fed will "need to see data" that shows the U.S. economy has clearly met the central bank's thresholds for a rate hike before it begins considering any tightening, Powell said.
"A transitory rise in inflation above 2%, as seems likely to occur this year, would not meet this standard," Powell said, indicating that the Fed would overlook a temporary burst in inflation as consumers return to normal spending patterns and the massive hit to inflation last spring falls out of annual calculations.
Under their new monetary policy framework, Fed officials have promised to keep rates unchanged until the U.S. achieves maximum employment and inflation reaches 2% and is on track to moderately overshoot it to make up for the extended period of time it spent below target.
Currently, inflation data remains below 2%. The personal consumption expenditures price index rose by 1.5% year over year in January, as did the so-called core PCE rate, which excludes food and energy prices.
The Fed's forecasts for PCE inflation indicate that it could rise by 2.4% year over year but taper off slightly after that. Fed officials expect PCE inflation of 2% in 2022 and 2.1% in 2023, slightly overshooting the central bank's target as intended.
Fed officials projected an increase in core PCE inflation of 2.2% year over year in 2021, 2% in 2022 and 2.1% in 2023.
FOMC members see the U.S. unemployment rate falling to 4.5% at the end of 2021, compared to its December 2020 forecast of 5%. The most recent data showed the jobless rate fell to 6.2% in February, but it remains far above its pre-pandemic level of 3.5%. Powell noted that the figure understates the shortfall in employment given the number of people who have dropped out of the labor market during the pandemic and added that employment remains 9.5 million below pre-pandemic levels.
Similar to inflation, Powell said the Fed will need to see "actual progress, not forecast progress" before starting to reduce its bond-purchase program. The Fed is buying $120 billion of bonds each month, a pace that Fed officials have said will continue until they see "substantial further progress" in meeting their goals. The Fed will communicate its assessment of the progress "very carefully" and will do so "well in advance" to avoid any surprises, Powell said.
Powell also declined to share any information on whether the Fed is planning on extending its year-long relief to big banks' supplementary leverage ratios beyond its March 31 expiration date. The Fed will make an announcement on the capital rule in the coming days, Powell said.