The SPDR S&P 500 ETF Trust (NYSE: SPY) is up more than 70% from its March lows, despite the U.S. economy still limping along due to the pandemic. A large part of that market recovery is thanks to the Federal Reserve’s aggressive stimulus spending, so investors are right to be concerned about the approach the Fed will be taking in 2021 and beyond.
Bank of America economist Michelle Meyer recently addressed five key questions investors may have about the Federal Reserve heading into 2021.
1. Will the Fed wait for inflation before raising interest rates? Meyer said “yes.” Under the basis of the Fed’s new “Flexible average inflation target (FAIT)” framework, Bank of America is projecting the next interest rate hike will come in the second half of 2024.
2. When will the Fed taper its asset purchases? The Fed is currently making at least $120 billion in monthly asset purchases to provide liquidity to the market. Meyer said investors shouldn’t expect that approach to change until 2022.
3. Will the Fed fight rising long-end rates? Meyer expects the Fed to allow “healthy” long-end rate rises driven by a better economy. However, the Fed could potentially fight “unhealthy” long-in rate increases driven by policy missteps, oversupply of Treasuries or any market liquidity issues.
4. What will the Fed’s upcoming Summary of Economic Projections (SEP) look like? Meyer is watching closely for two developments: an inflation forecast above the Fed’s 2% target and the Fed funds target distribution shifting toward rate hikes over time. She said an upside shift in the distribution of risks would also be an important signal.
5. Will the Fed address financial stability, inequality and climate? Meyer said these three issues could become increasingly important to the Fed under the current ultra-low rate environment. Investors should watch to see if and how these issues impact the Fed’s words and actions in 2021 under new leadership in Washington.
Benzinga’s Take: For better or worse, the Federal Reserve’s stimulus measures are the primary reason for the disparity between the struggling economy and a stock market at all-time highs. The biggest question for investors in the long-term is what will be the ultimate economic fallout from the unprecedented stimulus actions and will the economy be able to digest it in a healthy way.
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