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Fed Sees Brighter Outlook, but Keeps Rates Steady; No Hike Through 2023

The Federal Reserve kept interest rates and its monthly pace of bond buying unchanged Wednesday, and continued to signal that rates will remain near-zero through 2023 even as it acknowledged an improved economic backdrop.

The Federal Open Market Committee left its benchmark rate unchanged in the range of 0% to 0.25% and said it would continue its $120 billion monthly bond purchases.

"Following a moderation in the pace of the recovery, 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 said in a statement.

The central bank's policymakers appear in no hurry to hike rates, continuing to back rates to remain near-zero through 2023.

The Fed’s interest-rate outlook for 2021 through 2023 was 0.1%, unchanged from previous projections in December, the Fed’s Summary of Economic Projections showed.

The unchanged guidance on interest rates comes even as the Federal Reserve upped its outlook on growth and inflation in the wake of an improving economic backdrop amid a boost from stimulus and vaccine deployments.

The economy is expected to grow by 6.5% in 2021, and 3.3% in 2022, up from previous estimates of 4.2% and 3.2% respectively.

The Fed's efforts have been helped by a wave of unprecedented pandemic fiscal relief measures undertaken by the U.S. government. The latest fiscal relief package, the $1.9 trillion American Rescue Plan, together with the faster pace of vaccine roll outs have added fuel to the recovery.

But the improving economic backdrop has sparked inflation and U.S. bond yields into life, stoking speculation over whether the Fed will have to tighten policy sooner than expected.

The pace of inflation is forecast to improve to 2.4% in 2021, and 2.0% in 2022, compared with prior estimates of 1.8% and 1.9% respectively. Looking ahead to 2023, inflation is projected to reach the 2.1% target, up from 2% previously, though the Fed has reiterated that it would let inflation run above target for some time.

The updated guidance on inflation is in keeping with the Fed's narrative that the post-reopening inflation boom will be short-lived.

The second part of the Fed's dual mandate - to achieve maximum employment – has also justified its accommodative stance somewhat as the unemployment rate at 6.2% remains above pre-pandemic levels.

The unemployment rate for the 2021 is expected to come in at 4.5%, down from 5% previously, and fall further to 3.9% next year, down from a previous estimate of 4.2%. The unemployment rate was estimated to improve further, and eventually drop to 3.5% in 2023, down from a prior estimate of 3.7%.

Looking ahead, market participants expect the Fed to stick with its commitment to let inflation run hot, allowing bond yields to move higher as the central bank looks to achieve full employment.

“Breakevens are starting to price over 2% to almost 2.3% inflation so the market is fully expecting inflation, though I believe that the Fed is going to stay true to their words,” David Wagner, a portfolio manager at Aptus Capital Advisors, said in an interview with "The Fed is in a tough spot and isn't renowned for being proactive ... and will likely let the market push rates higher until something really breaks before [deciding] to act."

Fed chairman Jerome Powell suggested that the tapering was still a ways off as the economy has yet to achieve substantial economic growth. An eventual taper of bond purchases will be signaled well in advanced, the fed chief added.

"We will give a signal that we're on a path to possibly achieve substantial growth to consider tapering. I think what we've learned from the experience of these last dozen years, is to communicate very carefully, very clearly, [and] well in advance …" Powell said.

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