KResearch projects that the Federal Reserve (Fed) will maintain its policy rate within the range of 0.0-0.25% at its meeting on June 15-16, 2021. Although inflation will accelerate as economic activities pick up after cities reopen, some factors may ease. This stems from consumption to offset pent-up demand from the previous periods, bottlenecks in supply chains and the low base in the same period of last year. Thus, a temporary spike in inflation may not put pressure on the Fed to rush to withdraw accommodative monetary policy in the near term, and the Fed will likely continue to focus more on economic recovery than on inflationary pressures. The latest labor market data also reflects the fragility of the economy, which may take longer to fully recover in line with the Fed’s target.
At this meeting, the Fed is expected to keep its economic and inflation forecasts, including the Fed Dot Plot, close to the previous forecasts. Alternatively, if the economic and inflation projections are revised to be higher, Jerome Powell’s statement is expected to ease market concerns about an exit from accommodative monetary policy and maintain the accommodative stance through the end of this year amid high uncertainty.
The Fed’s resale of bonds to the money market via reverse repo in the past month has increased significantly as the U.S. Treasury has accelerated loan originations by drawing down cash deposits from the Fed, resulting in a surge in demand for the Fed’s reverse repo facilities. This has led to a significant increase in liquidity entering the financial system and the need to place funds in reverse repo facilities, which provide better yields than other alternatives with negative interest rates. This factor will drive bond prices higher and lead to lower yields amid rising liquidity, which will further fuel inflation and asset prices. As a result, the Fed may face a challenge in maintaining its accommodative monetary policy and may need to withdrawal such policy in the future, and eventually the Fed will have to let policy rate rise.
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