Will interest rates rise in 2021? Powell Says No Rate Hike, No Taper

Will interest rates rise in 2021? Powell Says No Rate Hike, No Taper. Investors sold U.S. dollars after Federal Reserve Chairman Jerome Powell made it very clear on Tuesday that there will be no interest rate hikes or tapering in the foreseeable future. 

Will interest rates rise in 2021?

The U.S. economy is recovering, inflation is on the rise and with more Americans getting vaccinated, the outlook is bright. In fact, Powell expects to raise the Fed’s 2021 GDP forecast to the range of 6%. Yet these improvements are not enough for the central bank to move away from their commitment to keep monetary policy easy until a sustainable recovery returns the economy to pre-COVID levels.

What did Jerome Powell say today?

In his semi-annual testimony on the economy and monetary policy Powell said substantial progress has not been made towards their goals.  The Fed is committed to using their full range of tools to support the economy and to help ensure that the recovery from this difficult period will be as robust as possible. Powell said job growth alone won’t drive their decision.

Investors didn’t believe him when he said rates need to remain at current levels until the economy reaches maximum employment and inflation hits 2% in early February.  Today he said they want to see inflation moderately above 2% for some time before tightening and when the time comes to change the pace of asset purchases, they’ll make their intentions very clear. There will be no surprises.

By pledging to keep interest rates where they are now for the next year or two, Fed Chairman Powell endorsed a decline in the U.S. dollar.  Inflation expectations was the primary reason for the surge in Treasury yields and now that Powell said he’s not worried about the increase, we could see rates descend from their highs. Combine that with the prospect of more spending and there could be further weakness in the greenback particularly the USD/JPY pair.

Sterling benefitted the most from the slide in the dollar with GBP/USD taking out 1.41. U.K. labor data was mixed. While employment change dropped by -114K in the month of November, four times more than expected and the unemployment rate rose to the highest level in 5 years, average hourly earnings growth was very strong.

Wages rose 4.7% against expectations for 4.1% increase. Numbers like this all but guarantees that the government will need to extend the furlough scheme but with Prime Minister Johnson providing a plan to open schools and ease restrictions, sterling traders are looking forward to jobs returning. 

In contrast, euro sold off against the U.S. dollar despite dovish comments from Powell. A lot of this has to do with ECB President Lagarde’s recent comments. She said they are watching  the rise in yields very closely which has some investors worried that they could take steps to drive the currency and rates down.

The focus shifts to Asia tonight with a Reserve Bank of New Zealand monetary policy announcement on the calendar. The RBNZ is widely expected to leave interest rates unchanged. The last time they met was in November and they were less dovish.

Since then, New Zealand’s recovery slowed but the global recovery accelerated. With the currency trading near three year highs, there’s little reason to believe that the central bank is considering a rate cut or a rate hike. The Canadian dollar held onto its gains while the Australian dollar consolidated.

Federal Reserve Chairman Jerome Powell signaled that the central bank was nowhere close to pulling back on its support for the pandemic-damaged U.S. economy even as he voiced expectations for a return to more normal, improved activity later this year.

“The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved,” he told the Senate Banking Committee Tuesday.

He also played down concerns of an inflationary outbreak from another big fiscal stimulus package or from an unleashing of pent-up demand as a growing number of Americans are vaccinated against the virus. And he called the recent run-up in bond yields that has unsettled the stock market “a statement of confidence” in a robust economic outlook.

The Fed is currently buying $120 billion of assets per month — $80 billion of Treasury securities and $40 billion of mortgage-backed debt — and has pledged to keep up that pace “until substantial further progress” has been made toward its goals of maximum employment and 2% inflation.

The chairman “gave absolutely no indication that the Fed is thinking about changing its very dovish policy stance,” Cornerstone Macro analysts Roberto Perli and Benson Durham wrote in a note to clients.

Powell’s testimony occurred against the backdrop of growing optimism about the economy as vaccines against the coronavirus are more widely disseminated and expectations of further fiscal stimulus from President Joe Biden and Congress mount.

Bond yields have risen on the economy’s better prospects and in anticipation of faster inflation. Some traders have also brought forward their expectations for the Fed’s first interest-rate increase since it slashed rates effectively to zero last year.

Powell said it was important to determine what was behind the higher bond yields, namely expectations of a return to a more normal economy.

“In a way, it’s a statement on confidence on the part of markets that we will have a robust and ultimately complete recovery,” he said.

Market price action was volatile in the aftermath of Powell’s opening statement text release, with 10-year yields initially rising a couple of basis points to 1.3875% session highs, before the move quickly faded and yields dropped back lower by about the same amount.

Will interest rates rise in 2021? Interest-rate swap markets are pricing the first 25 basis point of Fed hikes around mid-2023, versus the early-2024 time frame priced in at the beginning of this month.

Read More: Traders See Earlier Fed Hikes, Even as Goldman Cautions on Pace

Technology company shares led a decline in U.S. stock prices on Tuesday on concern that valuations had gotten out of hand amid higher bond yields and bets on faster inflation. Even with recent weakness, though, the S&P 500 index is still up more than 70% from lows struck last March.

Powell said he didn’t have an opinion on whether that constituted an equity market bubble, noting that there were opinions expressed on both sides of that proposition. “No one can really identify” a bubble, he said.

Powell allowed that loose monetary policy has played a role in pushing up asset prices. But he said that other forces were also at play, including expectations of faster economicgrowth.

“While we should not underestimate the challenges we currently face, developments point to an improved outlook for later this year,” Powell said. “In particular, ongoing progress in vaccinations should help speed the return to normal activities.”

In response to a question, the Fed chair said growth could come in this year at 6%. The economy contracted by 2.5% last year.

The economy started 2021 on a strong note, as retail sales and factory output accelerated. In the wake of the firmer data, last week boosted its 2021 growth forecast to 4.6% from 3.5% and said that could rise toward 6%-7% if Biden’s $1.9 trillion aid package is enacted.

The jobs market though has softened, with claims filed for unemployment benefits jumping to a four-week high in the most recent reporting period. Payrolls lastmonth barely rose, by 49,000, after a 227,000 decline in December, and while unemployment-dropped to 6.3%, that partly reflected more people leaving the workforce.

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  • Will interest rates rise in 2021?
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  • RBNZ Expected to Leave Monetary Policy Unchanged

“The high level of joblessness has been especially severe for lower-wage workers and for African Americans, Hispanics, and other minority groups,” Powell said. “The economic dislocation has upended many lives and created great uncertainty about the future.”

He reiterated the Fed’s pledge to keep short-term interest rates pinned near zero until the labor market has reached maximum employment and inflation has accelerated to 2% — and is on track to moderately exceed that level for some time.

The personal consumption expenditures price index rose 1.3% in December 2020 from a year earlier, well below the Fed’s 2% inflation target. After stripping out volatile food and energy costs, core inflation clocked in at 1.5%.

“I really do not expect that we’ll be in a situation where inflation rises to troubling levels,” Powell said.

Temporary Inflation

He said inflation will pick up in coming months as current price levels are compared to depressed readings a year ago, when the economy was virtually shut down, but that effect will be temporary.

Prices may also be pushed up later in the year by pent-up demand released as a growing number of Americans get vaccinated against the virus. But he said that the increase in inflation was unlikely to be large or long-lasting.

Some economists, most prominently former Treasury Secretary Lawrence Summers, have warned that Biden’s $1.9 trillion stimulus plan could lead to an overheating of the economy and much faster inflation — a concern that administration officials have pushed back on as exaggerated.

While Powell studiously refrained from commenting on the Biden package, he did say that there hasn’t been a strong connection between bigger budget deficits and inflation recently.

Estimated reading time: 8 minutes

Will interest rates rise in 2021? Powell Says No Rate Hike, No Taper via @goldsilverrepor
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