Subtle but substantive Fed shift may let inflation build
Policy change to let labor market run hot as long as prices don’t.
While the new average inflation targeting regime Chair Powell announced today was widely expected, he did surprise by releasing a unanimous change to the policy-setting Federal Open Market Committee’s (FOMC) “Statement on Longer-Run Goals and Monetary Policy Strategy.”
The change basically shifts the central bank to a symmetric view of its average inflation target but an asymmetric view with respect to its maximum employment objective. That is, the Fed still targets 2% inflation, only now over an undefined period of time, allowing for periods of symmetric undershooting and overshooting of inflation. This cements the Fed in a dovish position until inflation rises, a welcome turn stocks clearly are embracing as the current low-rate environment appears likely to stick around.
Regarding max employment, the FOMC has become asymmetric, still willing to adjust policy when employment is too low (unemployment too high) but NOT preemptively adjusting policy when employment is high (i.e., unemployment below its equilibrium level). To express this, the FOMC stated its “policy decisions must be informed by assessments of shortfalls of employment from its maximum level.” Previously, the policy would consider “deviations” of employment from its maximum level in setting policy.
This somewhat subtle change should prove inflationary over time, as it means the Fed will let a hot labor market ride and watch inflation performance as the guide to any policy change. This reinforces the view that the Fed no longer is a big believer in the Phillips curve—not a huge surprise, but a change that formalizes the near-death of this historical inflation-unemployment trade-off model as a tool in policy deliberations.
For perspective, under this new framework, a tightening similar to the Yellen/Powell 2015-2018 rate hikes will not be repeated in the future. Over that time, unemployment was at or below perceived equilibrium levels consistent with maximum employment, but the Fed’s preferred measures of inflation did NOT average over 2%. So, there is some big news buried under the surface here and it was enough to prompt today’s bear steepening in the U.S. Treasury curve, with 2-year yields unchanged and 30-year yields up 7 basis points.