The era of monetary policy dominance & investor fascination with central banks is coming to an end says Paul O’Connor, Head of Multi-Asset at Janus Henderson Investors

This was an important FOMC meeting, in which the Fed sought to unveil its new approach to forward guidance on interest rate setting, fleshing out last month’s new inflation-targeting strategy. The Fed’s guidance now is that interest rates will probably remain unchanged until “maximum employment” has been attained and “inflation has reached 2% and is on track to moderately exceed 2 percent for some time”.

This dovish message was reinforced by the first publication of the FOMC’s interest rate forecast “dots” for 2023, which show that the committee does not expect US interest rates to rise before the end of that year.

The Fed’s announcement didn’t have a meaningful impact on market interest rate expectations – before the FOMC, investors were already assuming that the next hike in US interest rates would not happen until 2024. Some might reasonably observe that the wording of this new “enhanced forward guidance” still leaves the Fed with plenty of flexibility in interpreting when to raise interest rates in the future. Still, the central bank made clear that, for now at least, it’s key objective is to anchor market interest rate expectations until meaningful progress has been made towards reaching its employment and inflation objectives.

The fact is, in recent decades, the US economy has rarely achieved the sort of economic conditions that are now presented as the preconditions for future interest rate hikes. Unless inflation expectations swing meaningfully higher, Fed-watching should become very boring from here on. It is no surprise that market measures of expected volatility of US Treasury bonds are now close to all-time lows.

The bigger picture here is that, after decades of rate cuts and balance sheet expansion, the major central banks are now reaching the limits of their current toolkits. While Chairman Powell was keen to assert that the Federal Reserve wasn’t “out of ammo” it nevertheless seems clear that most of the big monetary artillery has already been deployed in the battle against deflation. If growth or inflation do disappoint in the future, fiscal policy will have to take more responsibility for reviving macroeconomic momentum than it has done in recent decades. This is not just a US story – it also applies to the eurozone and the UK as well. The era of monetary policy dominance and investor fascination with central banks is coming to an end.