The Fed to tolerate higher inflation and strengthen focus on employment

The statement made by Chair Powell at the virtual Jackson Hole meeting was in the end more dovish than expected. The shift to average inflation targeting was largely expected and repeatedly hinted at by FOMC members in the past. What was somehow surprising was the fact that what will matter now for rates is not the deviation of the unemployment rate from its estimated equilibrium value but its shortfall from maximum employment. This clearly introduces an easing bias.

Highlights:

  • Speaking at the Jackson Hole virtual summit Fed Chair Powell announced a throughout revision of its monetary policy strategy, which went above expectations.
  • As widely expected, the Fed will shift to an average inflation targeting over the business cycle, allowing for temporary overshoots beyond the 2%. Noteworthy, though, the Fed will grant itself some wiggle room as the time span used to average inflation will not be defined precisely. 
  • The surprise was the asymmetric treatment of labour market outcomes: higher unemployment rate will get a bigger weight than low rates in the new Fed reaction function. This adds a further downward bias to expected rates.
  • The Fed signals a shift towards discretion and away from rules, as it acknowledged the difficulties in measuring with precision structural variables like the equilibrium unemployment rate. 

Download the full publication below

THE FED TO TOLERATE HIGHER INFLATION AND STRENGTHEN FOCUS ON EMPLOYMENT

RELATED INSIGHTS

COVID-19 FACTS & FIGURES
G7 finance ministers are expected to signal their support for extending a debt relief programme aimed at helping the poorest countries. SinoVac’s CEO said the company will be ready for worldwide distribution of its coronavirus vaccine by early next year. Moderna says it expect to produce 20 million doses of its experimental vaccine by the end of the year.
CHINA’S AGGREGATE DEMAND SHOWS SIGNS OF CATCHING UP
China’s August data set came in on the strong side. Even more importantly, the recovery seems to broaden to the demand side which had been lagging behind so far. However, in part the data may look too positive, as a payback effect from previous flooding may be involved. This implies that the outlook still needs confirmation.
HEADWINDS FOR A BREXIT TRADE DEAL ARE RISING
Yesterday, a UK government fresh legislation proposal – the Internal Market Bill - led to heated discussions in the House of Commons. According to the UK government, the bill is intended to guarantee the smooth functioning of trade and prevent disruptions between the four nations of the UK, if no deal is reached with the EU by the end of this year’s transition period.