- On 17 March, the Federal Reserve held rates near zero and foresaw no hikes until 2023.
- It expected higher inflation that year, but called it “transitory”; months later it would have to change course.
- Central bank forecasts also fail: a solid plan does not rest on rates staying where they are.
On 17 March 2021, the Federal Reserve held interest rates near zero and its projections foresaw no hikes until 2023, although it expected higher inflation that year. The message was one of patience: low rates for a long time, even with an economy beginning to recover and inflation set to pick up. It was, in practice, a promise that credit would not become dearer any time soon.
For the markets it was a reassuring signal, because it confirmed that money would stay cheap. But the promise rested on a specific assumption, that the rise in prices would be temporary, and that assumption would be put to the test in the following months. It is better to read this episode not as an anecdote about the Fed, but as a reminder of how much the financial environment can change in a short time. Anyone who took borrowing decisions assuming the promise was certain ran the risk of the scenario changing.
What the Fed said
The Federal Reserve is the central bank of the United States and sets the benchmark interest rate for its economy. Raising it makes credit dearer and cools demand; lowering it or holding it at minimum levels makes money cheaper and stimulates activity. That lever is a central bank’s main tool for influencing growth and prices. After its meeting, it kept that rate near zero and its projections contemplated no hikes until 2023.
The message was one of patience, and was aimed as much at investors as at companies and households: monetary policy would remain very favourable for a long time. Although the European Central Bank decides for the euro area, what the Fed does influences markets around the world and the dollar’s exchange rate, so its decisions are also felt on this side of the Atlantic. A stronger or weaker dollar, for example, affects companies that buy or sell in that currency.
“Transitory” inflation
The Fed regarded inflation as “transitory”: a passing rise linked to the reopening of the economy, which would not require raising rates. Months later it would have to change course. Central banks work with models and forecasts, and those forecasts, like anyone’s, can fail when the context changes. This is especially true in unusual periods, such as a pandemic, in which there are few precedents to compare with.
History is a reminder that central banks’ forecasts also get things wrong. This is not criticism but an observation: the real economy, with its bottlenecks, its changes in habits and its unexpected shocks, does not always behave as models assume. That is why a promise of low rates until a specific date is an intention, not a guarantee. Whoever plans prudently treats it as a possible scenario, not as a fact.
What to take from it
The practical lesson is not to build a financial plan on the assumption that rates will stay where they are. Anyone with variable-rate debt, or planning to borrow in the future, does well to study what would happen if the scenario changes. The same goes for savers: the return on cash depends on those decisions. Low rates make deposits and other low-risk instruments yield little, and it is worth knowing this when setting savings goals.
A useful exercise is to calculate how much the instalment on a loan would increase, or how much it would cost to refinance, if rates rose, and check whether the plan can bear it. If the answer is no, it is worth discussing with the adviser alternatives such as fixing part of the debt, staggering maturities or strengthening the cash buffer, without waiting for the change to arrive.
Prudence means allowing for the possibility that what is forecast may not come true.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
