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Policy

FOMC maintains 0% rate decision at July meeting

There is still ground to cover before the tapering of asset purchases starts

Summary

Fed Chairman Jerome Powell expects the Delta variant of COVID-19 to have muted economic impact and maintains inflation will be “transitory.”  

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The Federal Reserve continued to maintain the status quo at its July meeting, holding its target interest rate in the 0% to 0.25% range, while stating that economic indicators continue to improve thanks to vaccinations.

In a media release, the Fed noted, “The path of the economy continues to depend on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.”

The central bank will also continue with its monthly asset purchases of $80 billion in Treasury securities and $40 billion in mortgage-backed securities (which have helped smooth the flow of credit in the economy) until “substantial further progress” has been made towards its goals. The central bank is aiming for “maximum employment” and for inflation of 2% over the longer run.

The Fed’s continued accommodative stance means variable credit card interest rates, which are typically tied to the Fed’s target interest rate, will likely continue at current levels for a while. However, those with outstanding credit card debt should take advantage of today’s interest rates to clean house since rate hikes will have to come about at some point as the Fed starts achieving its targets on inflation and employment.

Impact of new COVID strains

In a related press conference, Federal Reserve Chairman Jerome Powell said that the Fed is still “a ways away from a rate hike” and the tapering off of its asset purchases is a more immediate concern. The Fed is watching to see how the Delta variant impacts the economy and Powell expects there is still “ground to cover” before the tapering process starts.

The Delta strain will likely have health consequences for many, but the economic consequences may be more muted, he expects. “With successive waves of COVID, there has tended to be less in the way of economic implications from each wave,” Powell said. While there is scope for additional strains of the virus to develop, the rise of vaccinations will help people get back to economic activity.

For instance, the economy performed better than expected in the face of the COVID wave last summer. People adapted to the situation, with homebuying moving online and restaurants pivoting to takeout food. With Delta, while there won’t be “significant lockdowns,” school districts may delay their openings, and people may wait a month to go back to work.

See related: Poll: 51% of U.S adults accrued more debt during the COVID-19 outbreak

Inflation spike will likely not linger

Although inflation rose to 3.9% in May on a year-over-year basis, per the Personal Consumption Expenditures index, the Fed still sees inflation as transitory. Powell believes the spike is tied to the economic reopening (as reflected in factors such as airfare) and should move down over time. He expects inflation expectations to fall as the reopening process moves through.

Asked to define “transitory inflation,” Powell noted that “There will be inflation, but the process will stop. Prices going up year upon year upon year, that’s inflation.” If there is no longer-term impact, he sees it as transitory inflation. If there’s a permanent mark on the inflation process, to the extent that people’s inflation expectations move up, that would make for more permanent inflation.

See related: Fed reports card balances rose in May

Labor market disconnect between supply and demand

As for a current mismatch in the labor market between demand for labor, based on job openings, and supply of labor, Powell noted that this is an unusual situation. “We hear from businesses all over the country that it’s difficult to hire people,” he said.

He sees a number of factors that might be holding back labor supply. For one, people looking for a new job, rather than just going back to their old ones, will likely take a while to find one. “There’s a speed limit on that” process, he noted.

There are also factors holding workers back from the labor market. People don’t want to go back to jobs that expose them to COVID. There are those caring for school children and elderly people, and there’s also the effect of enhanced unemployment benefits that could be holding others back. Powell believes these effects will wane and that people will go back to work.

Even though the unemployment rate is low, it doesn’t really reflect a dip in the labor participation rate (which includes the number of working-age people employed or actively looking for work), and the Fed is still not at its goal of maximum employment, Powell believes.

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