What Does The Fed’s Inflation Shift Mean?

What Does The Fed’s Inflation Shift Mean?

For those traders awaiting Fed chairman Jerome Powell’s speech at the Jackson Hole symposium this week, there was certainly little disappointment. The Fed chair announced major shift in the Fed’s inflation strategy or, what he called, a “robust updating” of its policy.

Powell announced that the bank has formally agreed to a new strategy of “average inflation targeting”, shifting away from the bank’s prior approach of targeting a fixed level. This shift essentially means that the bank will now allow inflation to move “moderately” above its 2% inflation target on the back of a period of time spent below the level.

Inflation Allowed To Run Hotter

This shift in policy has been laid out in a document called the “Statement on longer Run Goals and Monetary Policy Strategy”. In terms of the broad implications of the shift, the new approach means that the Fed will no longer be looking to hike rates as the inflation rate hits 2%. Furthermore, it means that provided inflation does not start to rise, the Fed also will not be looking to hike rates as the unemployment rate declines. Previously, the Fed, as with most central banks, has viewed low unemployment leads to high inflation and have, in the past, took pre-emptive action to offset this situation by hiking interest rates.

Speaking this week, however, Powell said that the bank was now moving away from the old way of thinking. Commenting on the new strategy, Powell said: “Many find it counterintuitive that the Fed would want to push up inflation. However, inflation that is persistently too low can pose serious risks to the economy.” Powell went on to say that the interest rate level which neither hold growth back, or drives it, has changed much in recent years and is likely to stay around that the level in the near term.

Fed Dealing With Different Situation

On more of a historical note, Powell said that the current situation was in stark contrast to that faced by the Fed 40 years ago when Fed Chair Volcker pushed through a series of rate hikes as a means of driving down inflation. The Fed instead, for some tie has been grappling with a situation where inflation has been too low. Powell explained that these conditions “can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations.”

While the policy shift has no immediate impact it does create a more interesting outlook for the Dollar and the US economy as traders will no longer be looking to trade a spike in US inflation in the same way. However, the question now is just how far above 2% the Fed will be comfortable with inflation going?

Technical Views

DXY (Bearish below $92.63)

From a technical viewpoint. The Dollar continues to trade lower this week with price still hovering around the $92.63 level. Price has made several attempts to break below the level but as yet continues to find buyers below. Should we see a firm break of the level, the next support to watch will be the $90.72 region. Bullish divergence on momentum studies is worth noting, however, an upside reversal might still materialise.

What Does The Fed's Inflation Shift Mean?

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