The Federal Reserve has two primary jobs: maintaining maximum employment and stable prices. How it achieves this is changing. Last week they made a significant announcement signaling that future monetary policy will be very different than policy of the last 40 years. Ever since the persistent inflation of the 1970’s, the Federal Reserve has taken proactive measures to keep inflation low, even if it meant allowing unemployment to run at above desired levels. In other words they have been biased towards the low inflation mandate. Moving forward, the Fed will now tolerate slightly above average inflation until the economy has reached “full employment”. The Fed also made clear it intends to keep its zero interest rate policy in place for an extended period of time as long as inflation remains under 2%. They went on to state, it ”will aim to achieve inflation moderately above 2% for some time, so that inflation averages 2% over time.” Based on current forecasts, near zero short-term interest rates could be in place for the next 3 years. Since inflation has averaged 1.72% the last 10 years, the Fed would tolerate inflation of 2.3% the next 10 years. Only time will tell if this will be the case.
A key takeaway from this policy is that it encourages ownership of inflation related assets, such as stocks, real estate and natural resources, and discourages ownership of cash, bonds and fixed income assets. If inflation runs 2.3% over the next decade, owning a 10-year Treasury bond will lose -1.6% annually in real terms. That doesn’t sound very appealing.
