The Fed’s New Policy Framework: Lower for Longer?

Fed Chair Jay Powell gave an official update to the Fed’s policy on inflation targeting.

In his speech at the annual Jackson Hole Symposium this morning, Fed Chair Jay Powell gave an official update to the Fed’s policy on inflation targeting. It was one of the most significant revamps in their policy strategy since 2012. Having deliberated on these changes for the past year and a half, the Fed is seeking to average out their inflation target of 2% over the long term. In other words, in periods where inflation consistently is under 2%, the Fed will structure monetary policy to aim right above the 2% threshold to average it out and meet their target over time. 

Since setting the inflation target at 2% in 2012, the Fed has only met that a few times in the past 8 years—averaging about 1.4%.

Real Vision Blog - Chart: Inflation Month Over Month - 2012-2020
Inflation Month Over Month - 2012-2020
Source: Bloomberg News

Powell today had said, “The persistent undershoot of inflation from our 2% longer-run objective is a cause for concern.” Averaging out their inflation targeting would help them avoid “an adverse cycle of ever-lower inflation and inflation expectations.” In an economy that thrives on credit and its growth, a deflationary environment causes the debt burden to increase in real terms. 

Low inflation is also a direct contributor to low rates, which, when an economic downturn occurs, significantly hampers the central bank’s ability to support the economy through a recessionary period. 

Source: Kansas City Federal Reserve Bank

In other words, the shift in policy is meant to expand strong labor market gains in order to reach more workers, in light of how the U.S. economic expansion prior to the pandemic benefitted minorities and women in finding jobs and the civil unrest that has erupted this summer. 

All in all – rates will be lower for longer, much longer, allowing the economy to run hot. 

Yields on long bonds took a brief dive just minutes before Powell’s address, but they ticked back up as the Fed Chair laid out his lower-for-longer vision.  

Real Vision Blog - Chart: U.S. Treasury 20-Year Yield (%)
U.S. Treasury 20-Year Yield (%)
Source: Bloomberg

A steepening yield curve makes sense in the context of the Fed’s new inflation-targeting regime, since investors demand a higher yield in order to receive payment in a currency that may be worth less.

Real Vision Blog - Chart: U.S. Treasury Yield Curve Today
U.S. Treasury Yield Curve Today
Source: Bloomberg

As we’re writing this, the 30 year flirts with the 1.5% threshold.

Real Vision Blog - Chart: U.S. Treasury 30-Year Yield (%)
U.S. Treasury 30-Year Yield (%)
Source: Bloomberg

The question we’re wondering is: could a breach of that key level be a catalyst for price action in equities as well as gold?


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