US Federal Reserve Updates Longer-Run Goals and Strategy
This morning, Federal Reserve Chair Jerome Powell announced a series of "updates" to its Longer-Run Goals and Monetary Policy Strategy. These updates, while not exactly riveting reading, will shape monetary policy in the United States for the foreseeable future and influence policymakers around the globe.
What are the Fed's Longer-Run Goals?
If you've watched Jerome Powell give a press conference in the past two years, you're familiar with the Federal Open Markets Committee's mandate, since he repeats them like the Word of the Day on Sesame Street. For those singing along at home, they are:
Stable prices; and
Maximum employment.
What will the FOMC do at the next meeting? That's easy, whatever they feel is appropriate to ensure stable prices and maximum employment. Why did the FOMC announce a change? Because they felt it was appropriate to maintain stable prices and maximum employment, of course!
The basic idea of these two goals is quite simple, really. The FOMC wants to keep rates low enough that business owners have access to credit and can employ people, but not so low that the money supply grows quickly and prices start inflating. It's a delicate balance that officials are supposed to use all the data available and their best judgement to maintain.
Why the Fed Needs to "Update" its Goals
You may have noticed that recent monetary policy favors one side of that balance pretty dramatically: rates have been cut to zero and quantitative easing programs have held up credit markets Weekend At Bernie's style.
So it makes sense that Jerome Powell would have to announce some "updates" to the old paradigm. These broke down thusly:
The FOMC's decision-making will now be informed by shortfalls of employment, not deviations from the maximum level;
The FOMC is still targeting 2% inflation, but inflation that averages 2% over time.
It's this last point that's most important, because inflation has fallen short of 2% for a while now. Changing this policy raises the ceiling on the level of inflation the FOMC can allow, and gives the FOMC latitude to keep rates lower for longer. Add in that the FOMC won't commit to a method for calculating average inflation, and you end up with what looks like free reign.
Low Rates to Continue
Right now, there are two forces keeping deposit rates in Canada at extremely low levels. The first is the vast amount of cash and cash equivalents that has accumulated on bank balance sheets: Canadian domestic banks have added over $320B in cash and cash equivalents since the start of 2020, more than doubling their cash position. This cash is obviously great for the underlying strength of the bank, but completely erases the appetite for liquidity that forces banks to offer competitive deposit rates.
The second and perhaps longer-lasting force keeping Canadian deposit rates low is the interest rates on offer from the Bank of Canada. If the overnight interbank lending rate is 0.25%, there's little incentive for banks to go much higher than that with the rates they offer to their clients.
Sure, locking clients into term deposits allays interest rate risk and provides a degree of certainty, but the value of this certainty is equal to the perceived risk that interest rates will change. If the most powerful monetary policy official in the world gives a press conference where he says that he's not really worried about inflation anymore, as Jerome Powell did this morning, all of a sudden interest rate risk seems like less of a concern.
Deposit rates will increase when two things happen: banks start lending out some of the money that has accumulated on their balance sheet, and central bankers start taking inflation seriously again. The first change might already be in progress, as homebuilders report record earnings, but the second could take some significant changes in circumstances.
How to Make the Most of What's Available
Low rates make effective cash management a more difficult proposition than before. To get any kind of meaningful yield on your short term cash requires a willingness to think outside the box.
Investors with the ability to look outside the big banks should do so. The majority of the cash that has accumulated on balance sheets has found its way to the big six banks, so they're even less likely than usual to offer attractive rates. We don't have access to monthly figures from all the Canadian credit unions, but from what we've seen they are less awash with cash than the big banks.
The Canadian credit union system offers a variety of options, including institutions with credit ratings and institutions covered by unlimited deposit insurance. Even the most conservative investors can find deposit options that offer attractive rates at risk levels they're comfortable with. Our team offers dozens of credit unions on our platform, so it's very likely that we have something that meets your needs.