S&P 500 and USDJPY: FOMC Strategy Run Down
S&P 500 and USDJPY: FOMC Strategy Run Down
The FOMC has continued to raise the target for the federal funds rate as economic conditions have strengthened and the economic outlook has improved. The pace of interest rate increases will continue to be a key factor in the economy’s path toward normalization, with core inflation expected to moderate throughout the year but stay well above the Fed’s 2% objective.

Taking the next step toward normalizing monetary policy, the Committee directed the Federal Open Market Committee (FOMC) Desk to undertake its Open Market Operations (FOMO) as necessary to maintain a federal funds rate target range of 1-3/4 to 2 percent. The Committee also directed the Desk to purchase Treasury bills at least through the second quarter of 2023 to maintain over time ample reserve balances at or above the level that prevailed in early September 2019.

Operational and Money Market Data:
Over the intermeeting period, market volatility declined notably, reflecting reduced investor concerns about the inflation outlook, and spreads of interest rates on corporate debt, mortgage-backed securities, and municipal bonds to comparable-duration Treasury yields narrowed. The one-month option-implied VIX decreased notably, likely reflecting continued downward pressure on risk premiums as investors adjusted to lower expectations for the future path of the federal funds rate.

Inflation Compensation:
Measures of inflation compensation (removal of volatile food and energy prices) declined notably, on net, during the period. Over the past 12 months, measures of core inflation, excluding these volatile components, have been on a relatively strong run.

Inflation is still largely driven by the consumer, and the labor market continues to strengthen. With that in mind, it is reasonable to expect that the Committee will be able to gradually remove accommodation from the economy and keep inflation at or near its 2% target until 2022.

The FOMC’s plan for removing policy accommodation is to begin reducing its holdings of agency mortgage-backed and corporate debt, along with longer-term Treasury securities, in stages over the course of this cycle. This will likely be accompanied by further increases in the fed funds rate, which typically damps spending and slows economic growth. The pace and duration of this process will likely remain a focus for central bankers for years to come.

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