Compass Money: Low Rates and Low Inflation – Are They Here to Stay?

On Friday, Goldman Sachs made a statement that it expects the Federal Reserve’s new inflation target of “averaged-out 2 percent” to boost stock performance, and it predicts inflation this year to be 1.48 percent before falling to 1.41 percent in 2021. This announcement means that the Fed is planning on allowing inflation to rise above 2 percent before increasing interest rates. This move is meant to account for lackluster inflation this and next year, and equities will be large beneficiaries of this action. 

Thus far, the Fed’s recovery plan has largely centered around maintaining near-zero interest rates while also pumping more than $3 trillion into the economy. This new plan indicates that the central bank will not raise rates for potentially many years, or at least through 2023, but Goldman Sachs strategists believe it likely will not be before 2025. 

While the Fed’s overall strategy has largely been applauded, questions still remain over why exactly inflation is still so low given the unprecedented levels of quantitative easing. For months, the Fed has been buying up treasuries, agency-backed securities, and corporate bonds, and it grew its balance sheet from $4 to $7 trillion this year. Given the sheer amount of capital that is pouring into the economy with this strategy, many people thought inflation would be a much larger concern. However, it seems as though the massive decline in overall aggregate demand caused by the pandemic has counterbalanced the growth in extra money in the market. 

Until inflation can naturally reach healthy levels again, there is little the Fed can do but allow interest rates to sit at record-low levels, leaving the U.S.with a low-rate environment for years to come. Goldman Sachs analysts say this means that as treasuries are handicapped by the low rates, capital will continue to shift to equities and stocks, allowing the market to continue its historic bull-run in the midst of a recession.