Not surprisingly, the April Fed Minutes betray quite a bit of consternation about the outlook for the US economy, which dove into a modern day depression in March, amid a forced shutdown tied to what Donald Trump has now taken to calling “a great and powerful plague”.
Minutes from last month’s meeting are stale and repetitive given investors heard more from Fed officials over the past couple of weeks than anyone could possibly hope to digest. Market participants have heard from Powell himself three times in seven days, including his “60 Minutes” cameo.
Of course, you needn’t try to parse the incessant chatter from monetary policy officials these days, because it’s all generally centered around one overarching theme. That theme: Things are really (really) bad right now.
As such, policy will remain accommodative until such a time as the risks have receded.
It’s not clear when that will be, but until then, assets will be purchased with digitally-created money, and in unlimited quantities.
Rates will be zero or lower, although the Fed is still clinging to the notion that NIRP isn’t coming to the US. STIR traders have other ideas.
The Minutes show officials patting themselves on the back for helping to avert a total collapse of the global financial system. To wit:
Equity price indexes were up substantially from the lows of late March, safe-haven demands for the dollar had receded, and measures of realized and implied volatility across markets had diminished. Market participants pointed to swift and forceful actions taken by the Federal Reserve, coupled with strong fiscal measures, and some indications of a slowing in the spread of the coronavirus (COVID-19) in major economies as factors contributing to these developments.
But, again, the outlook is uncertain. So uncertain, in fact, that the word “uncertain” comes up eight times (which is actually a lower count than I would have expected under the circumstances).
Front and center in the discussion on risks was the credit market. The Fed is also concerned about stability in developing economies and your capacity to pay the mortgage.
That said, market participants remained very uncertain about the economic outlook, and contacts highlighted an array of remaining risks, including those in corporate credit markets, emerging markets, and mortgage markets. In corporate credit markets, concerns about potential defaults were rising, and ratings agencies had put on negative watch or downgraded many issuers. In emerging markets, the steep decline in commodity prices was exacerbating financial pressures for some emerging market economies (EMEs), which were also facing strains arising from capital outflows and a reduction in trade activity. And in mortgage markets, the likely increase in mortgage delinquencies associated with forbearance polices and an eventual rise in defaults were sources of concern for bank and nonbank lenders.
Notably, officials are debating the proper forward guidance. We know rates will remain near zero, but we don’t know for how long and we don’t know what, specifically, the Fed is looking for before considering a change to its stance. State-dependent or date-dependent forward guidance is thus on the menu.
“Some participants commented that the Committee could make its forward guidance for the path for the federal funds rate more explicit”, the April Minutes read. “For example, the Committee could adopt outcome-based forward guidance that would specify macroeconomic outcomes—such as a certain level of the unemployment rate or of the inflation rate—that must be achieved before the Committee would consider raising the range for the federal funds rate”.
Suffice to say any such target outcomes would need to see the unemployment rate fall markedly from where it is right now. As bad as it is, the official print that accompanied the April jobs report obviously understates the true jobless rate, which will almost surely hit 20% in relatively short order.
That’s the state-dependent bit. Below is the color on possible date-dependent forward guidance (with some additional commentary on the balance sheet):
The Committee could also consider date-based forward guidance that would indicate that the target range could be raised only after a specified amount of time had elapsed. These participants noted that such explicit forms of forward guidance could help ensure that the public’s expectations regarding the future conduct of monetary policy continued to reflect the Committee’s intentions. Several participants observed that the completion, most likely later this year, of the monetary policy framework review, together with the announcement of the conclusions arising from the review, would help further clarify the Committee’s intentions with respect to its future monetary policy actions. Several participants also remarked that the Committee may need to provide further clarity regarding its intentions for purchases of Treasury securities and agency MBS; these participants noted that, without further communication on this matter, uncertainty about the evolution of the Federal Reserve’s asset purchases could increase over time. Several participants remarked that a program of ongoing Treasury securities purchases could be used in the future to keep longer-term yields low. A few participants also noted that the balance sheet could be used to reinforce the Committee’s forward guidance regarding the path of the federal funds rate through Federal Reserve purchases of Treasury securities on a scale necessary to keep Treasury yields at shortto medium-term maturities capped at specified levels for a period of time.
As far as the virus is concerned, Fed officials are, naturally, worried about a second wave. Disconcertingly, the Fed seems to think a worse-case outcome is just as likely as the baseline, which calls into question the very concept of a “base case” scenario.
“In light of the significant uncertainty and downside risks associated with the evolution of the coronavirus outbreak, how much the economy would weaken, and how long it would take to recover, the staff judged that a more pessimistic projection was no less plausible than the baseline forecast”, the Minutes read. Here’s what the downside looks like:
In this scenario, a second wave of the coronavirus outbreak, with another round of strict restrictions on social interactions and business operations, was assumed to begin around year-end, inducing a decrease in real GDP, a jump in the unemployment rate, and renewed downward pressure on inflation next year. Compared with the baseline, the disruption to economic activity was more severe and protracted in this scenario, with real GDP and inflation lower and the unemployment rate higher by the end of the medium-term projection.
The Fed was also worried that collapsing crude prices and the stress on farmers from lower commodity prices more generally, might exacerbate an expected deluge of credit events.
“Some participants expressed concern that low energy prices, if they were to persist, had the potential to create a wave of bankruptcies in the energy sector”, the Minutes say. “In addition, the agricultural sector was under severe stress due to falling prices for some farm commodities and pandemic-related disruptions, such as the closing of some food processing plants”.
If you’re curious as to why IOER wasn’t tweaked last month, here’s the rationale on that:
Later in the intermeeting period, short-term interest rates drifted lower and settled at near-zero levels. Although rates appeared stable, the manager suggested that circumstances could arise in which temporarily raising the per-counterparty limit on the overnight reverse repo operation would support policy implementation. The manager also noted that some market participants anticipated that the Federal Reserve might increase the IOER rate in order to move the federal funds rate closer to the middle of the target range and to address market functioning issues that could arise over time with overnight rates at very low levels. However, there appeared to be limited risk that the federal funds rate would move below the target range, as the Federal Home Loan Banks— the dominant lenders in the federal funds market—can earn a zero rate on balances maintained in their account at the Federal Reserve. Moreover, there were few signs to date that the low level of overnight funding rates had adversely affected market functioning, and trading volumes remained robust. The SOMA manager noted that the staff would continue to monitor developments.
Finally, it’s worth noting that there was some concern about leverage in the corporate sector headed into the crisis and the possible knock-on effect for banks.
“Participants saw risks to banks and some other financial institutions as exacerbated by high levels of indebtedness among nonfinancial corporations that prevailed before the pandemic”, the Minutes read. “This indebtedness increased these firms’ risk of insolvency”.
The word “virus” appears 27 times in the April Minutes, which you can read for yourself below.