Jerome Powell signals Fed to keep buying bonds even as outlook improves

Federal Reserve Chairman Jerome Powell signaled that the central bank was nowhere close to pulling back on its support for the pandemic-damaged US 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 said in the text of testimony to be delivered Tuesday to the Senate Banking Committee.

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.

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.

Inflation Expectations

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.

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.

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Interest-rate swap markets are pricing the first 25 basis point of Fed hikes around mid-2023, versus the early-2024 timeframe priced in at the beginning of this month.

“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.”

The economy started 2021 on a strong note, as retail sales and factory output accelerated. In the wake of the firmer data, Bloomberg Economics 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 last month 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.

“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 risen 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%.

“The economic recovery remains uneven and far from complete, and the path ahead is highly uncertain,” Powell said.

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