The Fed primarily looks at employment and inflation data
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Old Mandate: Traditionally, the Fed has had a dual mandate of maintaining stable prices and reaching maximum sustainable employment.
It tries to achieve these goals by controlling the fed-funds rates, which influence short-term market rates. When unemployment is high, it cuts rates to stimulate the economy and boost output.
Conversely, policy makers hike rates when inflation is rising to quell inflationary pressures.
In its new mandate, the Fed will not react anxiously when inflation runs hot, but rather allow it to stay above 2% for a sustained period of time to compensate for past periods when actual inflation was below the 2% target. This is known as an “average inflation target.”
New Mandate: In a new policy framework, agreed to by all 17 top Fed officials, the central bank said it would allow actual inflation to run above 2% for some period of time. Here are the key sticking points.
1. Policy makers are doubling down on one of a key mandate: strong labor markets:
The maximum level of employment is “a broad-based and inclusive goal that is not directly measurable and changes over time.”
2. Average inflation targeting:
“To anchor longer-term inflation expectation at this level, the FOMC seeks to achieve inflation that averages 2% over time, and therefore judges that, following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.”
3. The Fed strategy now includes a stable financial system:
“Moreover, sustainably achieving maximum employment and price stability depends on a stable financial system. Therefore, the FOMC’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the FOMC’s goals.”
4. Sometimes, the Fed’s dual goals of stable prices and a strong labor market are in conflict. Here is how the Fed will review this:
“The FOMC’s employment and inflation objectives are generally complementary. However, under circumstances in which the FOMC judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.”
In the past, the Fed will tend to become hawkish as inflation expectations rise (an indication of this can be seen from what is termed a breakeven inflation yields implied from Inflation-linked bonds) and being proactive in curtailing inflation expectations, actual inflation never really was given a chance to print above or even close to the inflation target of 2%. As such, actual inflation has stayed way below the target for prolonged periods. Switching to using actual inflation instead of inflation expectations explicitly will mean the Fed will now be reactive and will act with a lag to the rise of inflation.
This will mean interest rates will remain low for even longer and will be bearish USD in the longer run. If you are unsure of what inflation means, substitute it with “cost of living” and you can imagine how the world ahead is going to look like. Explicitly including a stable financial system as part of their framework may even seem to mean
Seek refuge in hard assets. Cash is the worst place to store your savings in the years ahead!