In its latest statement, the Federal Open Market Committee of the Federal Reserve determined that it will keep interest rates at almost 0% to stimulate the recovery of the economy that was strongly affected in 2020 due to the shutdowns to contain the COVID-19 pandemic.
Many investors are alarmed with the Fed’s decision, as they see inflationary pressures in the market and expect that the Reserve will have to raise interest rates earlier than expected to control inflation.
The Fed expects inflation to be moderate at just above 2% but will contain itself as vaccination continues and restrictions on the mobility of people, goods, and services are lifted.
The central bank also announced that it will continue to purchase at least $80 billion in Treasury debt securities per month and about $40 billion in mortgage-backed securities until there has been substantial progress on the Fed Committee’s employment and price stability goals.
The Fed finds itself in a complex situation
The U.S. unemployment rate currently hovers around 6%, whereas last year before the pandemic began the country had reached its natural unemployment rate at around 3.5%.
Stocks on Wall Street rose after the Fed’s announcement, as there will be greater liquidity in the economy, and this liquidity will be channeled to the financial markets. The dollar, on the other hand, suffered a fall against other strong currencies after the Central Bank’s announcement.
Bitcoin and other cryptocurrencies are expected to face a revaluation after the Fed announcement. Bitcoin had a small drop hours prior to the announcement, but quickly recovered after news that Morgan Stanley, one of the largest U.S. banks, confirmed that it will begin offering portfolios to invest in Bitcoin.
Inflation and a massive sell-off in debt securities have begun to replace Covid-19 as investors’ main concern this year, according to the Financial Times. Expectations of higher inflation have sent strong signals about the bond market. Indeed, the interest rate on one of the main indicators of the cost of debt, the 10-year treasury yield, rose to 1.6%, signaling a possible bubble in the market.
The reason why the increase in the interest rate of the 10-year Treasury yield alarms some analysts is because it is a sign that investors are moving their money into safe assets, such as Treasury bonds, to protect themselves from a possible downturn in the market.
Likewise, the Fed is in a complicated situation, as it could be forced to raise interest rates to contain inflation, but at the same time, it could cause a massive sale of securities in the market, (as it happened in 2013), causing the cost of debt to rise for the United States.
Other reserve assets that have risen in value are gold and silver, the main safe havens for investments when a crisis or slowdown in the economy is in sight, meaning that investors might be seeing a bubble coming up. In fact, following the Fed’s announcement, gold and silver prices actually rose slightly.
Despite the concerns of analysts and investors, the Reserve expects the economic recovery to develop quickly, thus counteracting any increase in inflation.
Meanwhile, investment bank Goldman Sachs updated its growth expectations and expects the economy to grow by 8% in 2021, boosted by the $1.9 trillion stimulus plan that was approved by Congress a week ago.