The Fed Upgrades Economic Forecast But Remains Steadfastly Accommodative

U.S. monetary policy was unchanged today as the Fed issued their official statement following their second meeting of 2021.

The biggest changes in the official statement were in this section covering current conditions: “…indicators of economic activity and employment have turned up recently, although the sectors most adversely affected by the pandemic remain weak. Inflation continues to run below 2 percent.” The Fed is staying on course with its low-rate policy and quantitative easing through their ongoing program of buying Treasury bonds and mortgage-backed securities. 

Behind the policy statement, the Fed released substantially upgraded forecasts for the economy that include higher inflation this year. 

The revised forecasts see inflation as measured by Personal Consumption Expenditures (PCE) Index reaching 2.4% in 2021 but then falling to 2.0% in 2022. Real GDP growth expectations for this year have been revised up to 6.5% from 4.2% previously. The headline unemployment rate is expected to fall to 4.5% by the end of this year and 3.5% by the end of 2023. 

Fed Chairman Jerome Powell emphasized that the inflation increase expected this year was transitory and consistent with their objective of seeing the economy get back to maximum employment while waiting to see inflation run above the inflation goal of 2%.

Median rate policy expectations were unchanged, which means the Fed officially sees no change in the current zero rate lower bound before the end of 2023. More Fed officials are starting to expect some rate increases in 2023, but they still represent a minority of the views.

This meeting again had a unanimous vote on the current policy.

Longer-term Treasury yields have been moving higher as the U.S. has moved more aggressively towards more fiscal spending under the new administration with Democrats in control of Congress.

Consumer loans like auto loans and mortgages are more directly related to these longer-term yields rather than the Fed’s short-term rate policy. Therefore, consumer rates are under pressure from the movement in yields. The 10-year yield is up more than 70 basis points so far this year.

However, consumer rates on auto loans have not moved as much as the 10-year yield as yield spreads have narrowed. In other words, consumers have seen less movement in rates than the movement in the 10-year, as lenders have been willing to accept lower yield spreads with strong loan performance and record vehicle values.

The movement in spreads is one input into our view of credit availability, which showed that auto credit loosened in February. We did see spreads widen modestly in February compared to January, but other credit factors improved leaving credit looser despite modestly higher rates. Average auto loan rates continue to be lower so far in March than a year ago.

With the Fed staying the course on monetary policy, trends in the economy and in the auto market are more likely to impact the rates consumers see on auto loans in the near term. The absolute bottom in consumer interest rates is likely behind us, but rates should continue to be attractive for most credit tiers.