Fed View: Dovish stance likely to be maintained, despite improving outlook –

The FOMC started its two day meeting yesterday in its first gathering of the Biden presidency, and the first meeting following the Democrat win of two Senate seats early this month. The new administration’s slim majority in the Senate – combined with an ambitious spending agenda – led us to significantly raise our growth forecasts last week.

We expect many on the FOMC are making similar reassessments of the outlook, and Chair Powell will no doubt be questioned on this in the press conference. However, the Fed will probably refrain from making meaningful changes to its policy statement at this stage, and we will have to wait for the March FOMC meeting to get a fresh set of projections from the Committee. We therefore expect Powell to maintain his dovish stance, and he is likely to dismiss suggestions that the looming avalanche of fiscal spending might pose risks to the inflation outlook.

Might Powell say something about the rise in yields? – One key focus for markets will be Powell’s take on the rise in longterm yields since the Democrat Senate wins, although this rise appears to have stabilised of late.

Some FOMC members – including centrist board members such as Vice Chair Clarida, but even typically dovish members such as St Louis Fed president Bullard – have been surprisingly relaxed about rising yields in their public commentary.

However, this comes with a caveat: that rising yields are fine as long as they reflect ‘increased optimism about the economy’, and by implication, inflation.

Indeed, we have found that almost all of the rise in yields so far has been driven by higher inflation expectations. As long as yield rises continue to reflect a rise in inflation expectations, we expect the Fed to remain relaxed. Should yields be pushed higher by less benign forces – such as market expectations of Fed hikes getting ahead of themselves – we expect the Fed to push back without hesitation.

Tapering not on the agenda for now – We also expect Powell to dismiss any suggestion of near-term tapering, repeating his recent promise to flag such a move well in advance. As a base case, we do not expect a tapering of asset purchases until next year. Any rate hikes meanwhile will come even later. While we last week changed our view and see potential for a hike in late 2023, any hiking cycle is likely to be much more limited and more gradual than the last cycle, given the Fed’s new policy framework (see our updated Fed view for more).