Farewell to the Fed’s Goldilocks approach to inflation targeting
- August 31, 2020
Treasury Advisory and Technology
Corporates | Denver, CO
SummaryAs we close out summer and brace for cooler weather, the Federal Reserve opened a new chapter on Thursday in its approach to monetary policy. They will shy away from the famed Goldilocks approach to managing inflation and articulated a new way of responding to economic challenges facing our economy.
The Fed’s dual mandate of controlling inflation while promoting maximum employment will now see a major shift in how it interprets and responds to inflation targets. At a virtual meeting of the Fed’s annual Jackson Hole symposium, Fed Chairman Powell formally assented to an “average inflation targeting” approach, which would allow inflation to run moderately above the Fed’s 2% goal for longer periods without the Fed responding by raising interest rates. While no formal maximum inflation number was released, economists believe the range would be around 2.25%-2.5%.
With U.S. unemployment hovering around 10%, the Fed also hinted at a more inclusive definition of full employment as it embraces a broader interpretation of the maximum unemployment rate. This would allow the Fed to be more tolerant of low unemployment numbers while chiseling away at the long-held belief that low unemployment and low inflation cannot coexist.
The immediate interpretation by the markets of the Fed’s new strategy is that the central bank would leave rates near zero for longer than initially forecasted. This had a mixed impact on government bond yields, with the 10-year treasury yield rising sharply and nearing 0.75% before paring back some of its gains. The Fed also appeared to put the yield curve control topic aside, at least for now, which could lead to slightly higher volatility in the months to come. With long term rates at historic lows, bond issuances on the rise, and mixed interpretations of policy changes, pre-issuance hedging continues to be a theme across corporates. We’ve seen clients dusting off risk management policies, exploring forward hedging much farther forward than historically, and revisiting the economic and accounting implications of their hedge product choices in the current environment.
(Related insight: Read “Hedging future fixed-rate debt” to learn how organizations are taking advantage of low long-term rates by locking in rates on future fixed-rate debt issuances.)
Following the Fed’s announcement, the U.S. Dollar (USD) fell sharply against most major currencies as markets embraced the prospect of low U.S. interest rates for longer periods. The U.S. Dollar Index, a comparison of the USD against a basket of currencies, was below 92.50 and nearing its low for the year. In addition, the resignation of Japan’s longest serving prime minister, Shinzo Abe, due to ill health, caused Japanese investors to pull back money from abroad fearing the end of a very expansionary monetary policy by the Bank of Japan. This led to a sharp rise in the Japanese yen (JPY) and other safe haven currencies.
(Related insight: Register for the webinar, “Strategic Considerations for Cross-Currency Swaps” on September 10 at 2 p.m. ET)
(Related insight: Download Chatham’s Benchmark Study Report, "The State of Financial Risk Management," to see what peer corporations are doing to manage FX risk.)
Although we have seen a strong recovery in jobs numbers over the last few months and hit record highs for equities this past week, much pessimism still exists around vast sectors of the U.S. economy as COVID numbers continue to rise. All eyes will be focused on the non-farm payrolls number for the month of August and whether businesses can continue to open with relaxed restrictions and rehire workers or revert to tighter shutdowns.
Talk to a hedging or hedge accounting practitioner about your program.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0338
Our featured insights
U.S. April employment data disappoints amidst concern for inflation
The U.S. gained 266K jobs in April, falling significantly short of survey expectations of +1M jobs, while Treasury Secretary Janet Yellen indicated that interest rates may need to rise.
Continued recovery spurred on by key data
Persistent Fed policy, optimistic economic data, and the ongoing recovery from the COVID-19 pandemic buoyed investors about the U.S. economic recovery. Worldwide recovery from the pandemic causes the U.S. dollar to weaken. Commodity prices hit multi-year highs as supply outweighs demand....
5 treasury trends to watch in 2021
To succeed in the 2021 marketplace, corporate treasurers must rethink their financial risk management objectives, strategies, and policies while addressing their team’s changing role within the organization. Recognizing these five trends can help treasurers prepare for success in the year ahead.
European Central Bank keeps stimulus torch lit as U.S. officials consider dimming the flame
Continued upward pressure on prices in the United States remains the economic theme as the Fed signaled more appetite for gradually reducing their bond buying program. This is in contrast with the European Central Bank’s continued economic stimulus.
Inflation acceleration makes Fed uncomfortable
Inflation continued to dominate conversations with elevated CPI numbers leading to tough questions for the Fed chair at his Congressional testimony. The 2-5 year treasury yields increased but long-term yields continued to fall. Meanwhile, OPEC reached a compromise with the UAE, agreeing to higher...
Volatility across all sectors as the market anticipates a slower recovery
COVID variants and disappointing economic data dominated the market this week, leading to volatility in all sectors. Treasury yields dropped before rebounding slightly to end the week. Oil hit a 6-year high on Tuesday before dropping off, and the U.S. Dollar showed continued signs of...
Market dissects confounding jobs report
The highly anticipated June jobs report delivered conflicting results with a strong beat in payroll expectations diverging from the slight increase in the unemployment rate. The dollar had another week of appreciation before cooling on Friday as interest rates dipped slightly. Oil prices neared...
"We have a deal"
Amidst rising inflation and looming fears of a Fed tapering, an exuberant President felt confident that a deal had been reached with a group of bipartisan senators paving way for a roughly $1.2 trillion infrastructure bill.
Hawks begin circling the Fed
The Fed holds short-term rates steady but indicates rate hikes in 2023. The Fed’s inflation expectation revised upward to 3.4%. Equities fall, dollar strengthens, and 10-year Treasury rates are mixed. The U.S. economic recovery continues.
CPI prints at decade high while Treasury yields plummet to quarterly lows
Inflation data last week printed at the highest level since 2008 as investors weighed its transitory nature. Signaling expectation of continued dovishness by the Fed amid economic reopening, stocks hit record highs. Curiously, Treasuries also rallied as yields fell to three-month lows.
Market reacts to Fed commentary and May jobs report
The market parsed through Fed commentary during the week that hinted at a slightly more hawkish stance before turning its focus to the May jobs report. The nonfarm payroll numbers were slightly below expectations, easing concerns of earlier-than-expected rate hikes and mildly weakening the...