Fed Gives the Economy Room to Run

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Special Guest Blogger: Tim Kearney

There are various theories why the Federal Reserve is on hold, including economic weakness in the manufacturing sector and the recent risk-asset swoon. Each is important, but I’ll throw out there that the key for policymakers is the drop in the inflation rate. Officially, the Fed has two objectives: maximize employment and maintain a stable inflation rate, which is currently defined as 2% per year for the personal consumption expenditure (PCE) price index. That measure peaked at 2.4% in July 2018 and since then has fallen steadily. Currently, PCE is 1.5% — far below target.

That the Fed finds this to be an issue can be seen in the press release after the Federal Open Market Committee’s April-May meeting, in which the FOMC reminded the market that its target inflation rate is plus or minus 2%, implying that it is content to see the inflation rate move higher even though the unemployment rate is at a 50-year low. In prior cycles that would have prompted the Fed to keep its foot on the brakes, but not this time.

I’d say that the Fed has it right to allow the economy to run strongly for the first time in over a decade. In a recent speech, FOMC Governor Lael Brainard characterized “maximum employment” as “the highest level of employment consistent with” the 2% inflation target. That’s a green light for a lower unemployment rate and growth — good fundamentals for the equity market.

Please see Voya Global Perspectives page 39, “Monetary Policy Outlook.”

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