Kerry Craig

Macroscope | The Fed may be in tune but will inflation eventually spoil the party?

Investors will be weighing how credible the Fed’s outlook is for a US economy supercharged by a massive stimulus boost that may cause inflation to spike

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A trader works on the floor of the New York Stock Exchange on March 10 when stability in the bond market translated into gains for stocks. Photo: AP

Kerry Craig

Published: 1:30am, 20 Mar 2021Updated: 2:10am, 20 Mar 2021

The US Federal Reserve met this week to decide on interest rates and policy projections. The meeting had been hotly anticipated, as it was expected to set the tone for the central bank’s policy response to rising bond yields (bond yields move inversely to prices).

As it turned out, there was little to see – the Fed kept the song the same. Committee members remain in harmony on interest rate hikes.

The question now for markets is: how credible is this outlook when the US economy will be supercharged by a massive stimulus boost that may cause inflation to spike?

There were no changes to the Fed’s policy setting, cash rates remain anchored in the 0-0.25 per cent range where they have been since March last year, and the bond purchase programme will continue to tick over at the rate of US$120 billion per month. This is a very loose policy setting, considering how the Fed views the outlook for economic growth and inflation in the coming quarters.

The Fed could not overlook the fairly quick recovery in the US economy this year, helped by a fast clip of Covid-19 vaccines. The higher rate of Covid-19 infections in the US, coupled with the speed at which vaccinations are being distributed, implies the country may reach herd immunity as soon as the next few months, enabling an even faster economic reopening and perhaps higher rates of inflation.

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This upside risk to inflation is hard to measure exactly, given it’s still not clear how much long-term damage Covid-19 did to the US economy, and it isn’t certain just how the US$1.9 trillion fiscal package will trickle its way from US households into the economy or asset markets.