US Fed set to upgrade forecasts for US economic growth

The Federal Reserve is poised to upgrade its forecasts for the US economy on Wednesday, pointing to an acceleration of America’s recovery from the pandemic that will test the central bank’s willingness to maintain ultra-loose monetary policy in the years ahead.

At the end of a two-day meeting of the Federal Open Market Committee, economists are expecting the central bank to make a significant upgrade to its December prediction that the US would grow by 4.2 per cent this year, with core inflation at 1.8 per cent and the unemployment rate dropping to 5 per cent.

Many private sector economists have already upgraded their forecasts on the back of US President Joe Biden’s $1.9 trillion (€1.6 trillion) stimulus and a faster vaccine rollout, with more than 2.4 million Americans receiving a jab each day.

Changes

Although the Fed is not expected to make any big policy changes on Wednesday, more upbeat projections are likely to intensify investor debate over when the central bank will start removing its support for the economy.

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The Fed meeting is taking place at a delicate moment for the $21tn market for US government debt. Treasury yields, which rise as prices fall, have shot higher in recent weeks during bouts of frenetic trading as investors have revised their growth and inflation forecasts higher while also pulling forward the expected timing of the Fed’s first interest rate increase.

In December, the median of Fed officials’ estimates did not signal a rise in interest rates until at least 2024. The central bank has said inflation would have to reach 2 per cent and be on track to exceed that target while reaching full employment for it to make such a move.

However, Fed watchers are now evenly divided on whether US central bankers will signal that the first rate increase could come as early as 2023.

“With these sorts of upgrades, more likely than not, the median will show a hike [IN 2023], although that’s actually quite controversial,” said Jan Hatzius, the chief economist at Goldman Sachs. “If you look at some of the forecasters’ surveys there are different views on this,” he added.

Debt

So far, Jay Powell, the Fed chair, has stressed that the US central bank is far from achieving its goals for the US recovery, suggesting little concern among the central bank’s top brass over rising debt yields or inflation in the context of an improving economy.

But Powell’s apparent willingness to tolerate the sharp rise in yields so far has rattled investors, helping to push 10-year yields even higher. The benchmark 10-year bond now trades around 1.6 per cent, having hovered at 0.9 per cent at the start of the year.

Powell disclosed at his last public appearance before Wednesday’s meeting that “disorderly” moves resulting in tighter financial conditions would concern the central bank. But so far, the increase in yields is viewed by many Fed officials as a natural product of the improved outlook. While it has caught their attention, it has not been extreme enough to imperil the recovery, US central bank officials have suggested.

Investors have cut their holdings of Treasury futures as growth and inflation expectations have edged up, data from the Commodity Futures Trading Commission show.

Yields

And some money managers have positioned themselves for a further increase in yields. Asset managers are now net short the 10-year and ultra-10-year Treasury futures contracts, in a sign they believe bond prices could fall further.

Scott Thiel, chief fixed-income strategist at BlackRock, said: “The market is testing when the Fed will say enough is enough.”

David Norris, head of US credit at TwentyFour Asset Management, said: “Given the pace of recent developments it is easy to see why some market participants are getting twitchy. . .We would certainly expect the Fed to act should it begin to see evidence of a material tightening.”

Strategists predict the sell-off in government debt will accelerate in the absence of a change in posture from the Fed. Goldman Sachs, Société Générale and Credit Suisse recently updated their forecasts and now predict 10-year Treasury yields to reach 2 per cent by the end of the year. – Copyright The Financial Times Limited 2021