Wednesday the FOMC left policy unchanged as expected. That said, the modest alterations to the statement and Fed Chairman Jerome Powell’s comments made clear that the Fed increasingly sees the upside potential for later this year. At the same time, however, Powell emphasized that any talk of removing policy accommodation was premature given the inflation dynamics. Effectively Powell was bending over backward to instill credibility in the Fed’s new policy strategy. That means that even though he is bullish on the economy, the Fed will nonetheless hold the pedal to the metal. Don’t go looking for the Fed to tame asset prices with higher rates. The Fed’s focus is squarely on jobs and inflation.

The key change in the statement this paragraph in December:

The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.

Evolved into this:

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 addition of vaccinations reveals the Fed is keenly aware that the pandemic will most likely be brought under control this year with the exact timing dependent on how quickly we can get shots in arms. The timing of vaccinations is thus critical to the timing and magnitude of the recovery. The exclusion of the near and medium-term guides reflects that the public health risks are really about the near-term at this point with the medium-term risk mitigated by the vaccines. Powell described the change like this:

So in the statement on the language, we dropped in the medium term it’s the rollout of the vaccine, the arrival of new strains that are more contagious and dangerous. When we were thinking medium term we were thinking scars and things like that. Nonetheless to go to your second question, as I mentioned in my opening remarks, there’s good evidence to support a stronger economy in the second half of this year. In fact, if you look as we do at a range of private forecasters, what was their forecasting in December and what’s their forecast now, right across the board much higher forecast for 2021 growth because of the on going rollout of the vaccine and CRA act getting done. There is a positive case there, but that — think of that as the sort of base case is a strong economy in the second half of the year. The language says there’s still — I forget the exact language, down size risks — we used an adjective. It was considerable risks to economic outlook. There are considerable risks of economic outlook nonetheless that is a more positive outlook and that’s how I would parse that for you.

Powell revealed that his optimism reflects that the economy is more resilient than expected:

The other thing, even conditional on that, when we say the wave in the south and west, the wave of cases this summer, I think intuitively having seen what happened in March and April, we expected there to be a significant hit to economic activity and people kind of just got on with their lives and dealt with it. It had a much smaller effect on economic activity than we expected. Then comes the fall wave which is just so much larger, very large wave as was very much forecast people going indoors, the weather all that. Even there look at the December jobs report. So big job losses and, you know, that part of the service sector, I mentioned 400,000 jobs in bars and restaurants, another hundred thousand in similar kinds of activities. If you look elsewhere, it’s not having an effect. You know, purchasing manager index, incentive index on areas of the economy not really directly exposed to the pandemic in their economic activity, they’re doing okay. They are. Housing is a great example. You know, the way the housing industry worked when you buy a house there was a lot of in person contact.

Note Powell’s take on the December jobs report. As I have said before, the private job weakness was very sector specific. Private employment excluding leisure and hospitality was up 403k jobs and the three-month average was at 468k jobs. It was a good report that revealed the resilience of the economy. Powell sees that and is buying the story that the pandemic is the most critical impediment to the economy and once we contain the pandemic the economy can bounce back quickly:

I would just urge that — I know people are working hard on that, but that is really the main thing about the economy is getting the pandemic under control, getting everyone vaccinated, getting people wearing masks and all that. That’s the single most important economic growth policy that we can have.

Despite a generally bullish outlook, Powell steadfastly refused to give any indication that the Fed intended to talk about tapering or hiking rates anytime soon. He leaned heavily on the Fed’s new policy strategy to defend its position. The Fed remains too far away from reaching its goals to think about removing accommodation. On jobs:

In a world where almost a year later we’re still almost 9 million jobs at least, that’s one way of counting can be counted higher than that, short of maximum employment, people out of the labor force, the real unemployment rate is close to 10 percent if you include people in the labor force, it’s very much appropriate that monetary policy be highly accommodative to support maximum employment and averaging two percent over time.

And:

…the reason we talk about inequality and racial inequality in particular, it goes to our job which is to achieve maximum employment which links up with we want the jobs to be as high as it can be, everybody can take part and put their labor in and share in the prosper in our economy, that’s what we want.

Moreover, Powell pushed back hard on inflation concerns. He emphasized that the Fed would not be fooled into an inflationary scare attributable to either base effects or the initial phase of a rebound. Importantly, he very carefully explained that the economy has been locked into a disinflationary dynamic that will not be easy to change. For example:

…it helps to look back at the inflation dynamics that the United States has had for some decades and notice that there has been, you know, significant disinflationary pressure for some time for a couple of decades. Inflation has averaged also than two percent for a quarter of a century and the inflation dynamics from the flat Phillips curve and low persistence of inflation changes over time. It evolves constantly over time but don’t change rapidly. It’s very unlikely anything we see now would result in troubling inflation. Of course if we did get sustained inflation level that was uncomfortable, we have tools for that. It’s far harder to deal with too low inflation.

The Fed is not afraid of inflation getting out of control. The Fed is more afraid of making the mistakes of the last recovery and withdrawing support for the economy too early. The Fed will not hike rates until inflation exceeds 2% on a sustained basis. This is not the forecast of inflation, this is actual inflation. The Fed expects us to take these promises seriously and stop worrying about rate hikes until something interesting happens on the inflation story. And stop worrying about tapering until we see some data confirming the growing optimism for this year’s outlook.

The Fed will also not let financial stability fears deter it from its inflation and employment goals. This topic has gained renewed attention with the GameStop surge, a topic that Powell deferred from commenting on directly. With regards to financial stability, the issue is not just one stock:

 So on matters of financial stability, we have a framework. We don’t look at one or two things. We made the framework public after the financial crisis so it can be criticized and held accountable. We look at say set prices and look at leverage in the banking system and non-banking system and corporates and households and we look at also funding risk. If you look at across that range of readings, they’re different and we monitor them careful. Overall it’s moderate. Our overall goal is to assure financial system itself is resilient to shocks of all kinds and it’s strong and resilient and includes not just banks but money market funds and different kinds of non-bank financial structures as well.

I take this to say that even if assets were broadly overvalued (yes, I know, many of you think that is the case), the Fed’s concern would heighten only if the overvaluation looked to be a factor in creating a systemic risk to the financial system as a whole. That seems like a pretty big hurdle to clear anytime soon. If having failed to get the Fed to reduce accommodation on the economic outlook market participants think a financial stability story can achieve the same goal, it won’t.

Bottom Line: Powell is trying to do two things. First, recognize the improving economic outlook. Second, make clear that this improvement has not yet impacted the Fed’s expected policy path. The new strategy is very clear that forecasts alone are not sufficient to justify reducing policy accommodation. Forecast-based inflation fears failed the Fed in the last recovery and they expect the same would happen now. As a result, the focus is squarely on results. Considerable progress toward goals needs to be made before tapering. Sustained inflation needs to occur before raising interest rates. The Fed will continue to pound on this message. Also, Powell is not impressed with anyone’s concerns about asset bubbles. It’s all about inflation and jobs.

Note: The Powell quotes are from an unedited transcript and may have some grammatical errors.