How the FED intends to support the US economy and what this means for markets
Today, Powell said that the FED would be initiating a new approach to inflation, referred to as targeted inflation. This is essentially where a central bank will target a specific inflation rate as a goal, adjusting monetary policy to gear towards this target.
The inflation target announced by Powell, head chairman of the Federal Reserve was 2%, i.e the FED will aim to achieve this specific level of inflation over time, taking a more relaxed view on inflation concerns and unemployment rates citing :
“This change reflects our appreciation for the benefits of a strong labour market, particularly for many in low- and moderate-income communities.”
This new approach does not include a targeting unemployment level which normally goes hand in hand with inflation levels and as a result, inflation can rise above 2% before the FED needs to take action. Inadvertently what this all means is that the FED can keep interest rates low for an extensively long period of time, without running the risk of high inflation.
So how does the plan intend on reaching this 2% inflation target?
Short answer, we don’t know. Powell did not reveal the specific details surrounding this question, however, it is expected we will get more forward guidance and further intentions on asset purchasing programmes in September. We do know that decisions will be made based on “shortfalls of employment from its maximum level”.
What does this mean for markets
Through this new initiative will allow inflation to stretch beyond 2% (i.e more flexibility), Powell did say he expects any overstretch to be manageable, but there is a real risk that this might not be the case. Either way, the initiative suggests a longer period of time without interest rate hikes which would support safe-haven assets in the long term. So why did gold fall then you might ask?
Well, analysts say that although the inflation targeting scheme is dovish (bearish for USD), it is perhaps not as dovish as market participants thoughts, add to the fact that Powell said any overstretch in inflation as part of the ‘flexible’ nature, will not result in any major jumps in inflation – has given markets a fall-safe to fall back on.
In the short term, the dollar remains somewhat undecided, there are month-end flows which is typically bearish for USD, but weather markets focus on the failsafe aspect of this new program or longer-term implications of it, is still undecided so we will have to wait and see. Worth noting, US elections will be taking place in less than 40 days, this should keep volatility at interesting levels.