Fed sharply upgrades US growth forecast to 6.5% for 2021   

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Federal Reserve officials sharply upgraded their growth forecasts for the world’s largest economy but signalled that they expected to keep interest rates close to zero until at least 2024.

The median estimate from Fed officials now predicts that the US will grow by 6.5 per cent this year, compared with 4.2 per cent in its December forecast.

The rosier projections from the Fed came at the end of a two-day meeting of the Federal Open Market Committee on Wednesday. It was held against a backdrop of growing optimism about the US economy in the wake of Joe Biden’s $1.9tn fiscal stimulus and the country’s swift vaccination rollout.

Core inflation is expected to rise to 2.2 per cent — above the central bank’s 2 per cent target — compared with a smaller rise to 1.8 per cent predicted in December. The unemployment rate is now forecast to fall to 4.5 per cent by the end of the year instead of 5 per cent.

“Following a moderation in the pace of the recovery, indicators of economic activity and employment have turned up recently, although the sectors most adversely affected by the pandemic remain weak,” the FOMC said.

The FOMC made no changes to its ultra-loose monetary policy on Wednesday, pledging to maintain rock-bottom interest rates until the economy reached full employment, with inflation hitting 2 per cent and on track to exceed that target.

It also reiterated that it would continue to buy bonds at a rate of $120bn per month until “substantial further progress” was made towards its goals.

“The path of the economy will depend significantly on the course of the virus, including progress on vaccinations. The ongoing public health crisis continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook,” the FOMC said.

However, the sharp upgrade to the Fed’s summary of economic projections will test the central bank’s willingness to keep that stance in the years to come, and will intensify investor debate over when the central bank will start removing its support for the economy.

In December, the median of Fed officials’ estimates did not signal a rise in interest rates until at least 2024, an overall assessment that was unchanged on Wednesday despite the better outlook.

But four out of 18 Fed officials are now forecasting a rate increase in 2022, while seven are expecting one in 2023, signalling that US central bankers are turning more hawkish, according to Wednesday’s projections.

The Fed meeting comes at a delicate moment for the $21tn market for US government debt. Treasury yields, which rise as prices fall, have shot higher in recent weeks during bouts of frenetic trading as investors have revised their growth and inflation forecasts higher while also pulling forward the expected timing of the Fed’s first interest rate increase. 

A sell-off on Wednesday, which had pushed 10-year yields to the highest level since last February, moderated slightly following the publication of the FOMC statement. The benchmark bond slipped to 1.65 per cent in afternoon trading in New York, having traded as high as 1.68 earlier in the session. The yield on 30-year bonds remained elevated around 2.44 per cent.

The S&P 500 was lower by 0.2 per cent, while the tech-heavy Nasdaq Composite dropped 0.5 per cent.

So far, the increase in yields is viewed by many Fed officials as a natural product of the improved outlook. While it has caught their attention, it has not been extreme enough to imperil the recovery, US central bank officials have suggested.

But Powell’s apparent willingness to tolerate the sharp rise in yields unless the moves were “disorderly” has rattled investors so far, adding fuel to the sell-off in US government debt.

“Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to US households and businesses,” the Fed added in its statement on Wednesday.

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