September 14, 2020 – Morgan Stanley said the Federal Reserve’s recently-announced inflation-targeting framework will likely spur U.S. inflation.

The so-called “flexible average inflation-targeting” framework rejects formulaic time horizons to measure average inflation, but instead allow the Federal Reserve to tolerate an inflation “overshoot” during recoveries to offset inflation shortfalls during economic downturns.

Chief Economist Ellen Zentner and colleagues said:

Over time, the change in monetary policy dynamics should feed through to inflation expectations, which are relevant to price and wage setting. By running looser policy for longer than in previous cycles, the Fed will allow inflation to rise above 2% for a sustained period. This supports Morgan Stanley’s out-of-consensus call for higher inflation and jibes with our longer-term forecast of higher inflation in Life After Covid.

According to analysis by the Wall Street Journal, had the strategy been adopted five years ago, the Fed would have likely delayed rate increases that began in late 2015, following seven years of short-term rates pinned near zero.

Two portfolio managers BuyMuni spoke to opined that inflationary expectations have had a “noticeable” price impact of municipal securities outside of ten years, even as Fed liquidity continue to provide a support level to asset prices including municipal bonds.

“As fixed income investors, inflation is always value-corrosive although higher asset prices and wages may benefit municipal credit over the longer term”, said an investment manager for a Manhattan family office.

Ten-year MMD yields have tapered higher from 0.58% on August 10 to 0.84% in September 11, a 40% increase in a month.

The Jackson Hole symposium was held on August 27-28, but leading up to the meeting, markets were abuzz that Chair Powell would announce a dovish policy in regards to inflation.

Contact Karen Bigelow at KBigelow@buymuni.com.