The prospect of a Janet Yellen Treasury and the public spat between Steve Mnuchin and Jerome Powell forced market participants to ponder the November FOMC minutes through a different lens.
In short: The dispute between Mnuchin and Powell over the expiration of some emergency liquidity programs ostensibly raised the odds of the Fed moving forward with WAM extension at the December meeting.
The assumption was that the Fed would want to get out ahead of any potential tightening in financial conditions that could accompany a market swoon or a double-dip recession tied to renewed virus lockdowns. Extending the maturity profile of monthly asset purchases would be one way to do that.
While WAM extension has long been viewed as the next step for the Fed, Mnuchin’s decision to end a hodgepodge of key facilities at the end of December leaves Powell to confront any adverse events without the full suite of tools made available early in the pandemic. So, bringing forward the WAM move could help insure against such a scenario.
However, the subsequent news that Yellen will be taking over for Mnuchin potentially ameliorates the need to add accommodation, given that she’ll presumably ensure that Treasury is supportive of whatever the Fed feels like it needs to do — and vice versa.
All of that is “new” since the November Fed meeting, so it’s not as much about parsing the minutes for clues on what’s coming in December, as it is reading them in the context of what’s happened over the last several weeks, and then updating your view for the odds of WAM extension being unveiled next month based on that contextualized reading.
The minutes reveal that the FOMC was “briefed on options for changes to asset purchases.”
“While participants judged that immediate adjustments to the pace and composition of asset purchases were not necessary, they recognized that circumstances could shift to warrant such adjustments,” the minutes read. “Accordingly, participants saw the ongoing careful consideration of potential next steps for enhancing the Committee’s guidance for its asset purchases as appropriate.”
Needless to say, the real-time economic situation has become more tenuous since early November as the virus spread and local governments moved to implement containment policies. That, even as the lagging data (which in this case just means October’s numbers) suggested the fourth quarter was off to a solid start.
“The staff discussed various changes the Committee could make to the structure of its purchases, including to their pace and composition as well as to the guidance the Committee has been providing to the public about its future asset purchases,” the account of the meeting went on to say. “The staff discussed the structure of asset purchase programs of several foreign central banks and how they have evolved during the pandemic.”
During his post-meeting press conference earlier this month, Powell attempted to strike a somewhat guarded tone, but as ever, emphasized that adjustments are possible. “We have a number of parameters we can shift and twist,” he said, responding to a question about whether ongoing gridlock in D.C. might force the Fed’s hand when it comes to additional accommodation. “We can deliver more accommodation if appropriate. It depends on the circumstances.”
Well, the “circumstances” haven’t changed much when it comes to Congress’s apparent unwillingness to deliver stimulus during the lame duck session but, as noted above, they have changed with regard to what crisis-fighting tools will be available to the Fed going forward.
Many participants, the minutes show, favored enhancing the guidance around asset purchases soon, while “a few” saw a need to extend the emergency facilities. Most participants favored linking bond-buying to economic outcomes, and speaking of the economy, most officials judged the pace of labor market improvement to be slowing.
Asset purchases are viewed as “insurance” against risks. “With market functioning seen as having largely recovered, many participants indicated that the role of asset purchases had shifted more toward fostering accommodative financial conditions for households and businesses to support the Committee’s employment and inflation goals,” the minutes note, but many participants “judged that asset purchases [also] helped provide insurance against risks that might reemerge in financial markets in an environment of high uncertainty.”
Suffice to say Mnuchin’s decision to end several key liquidity facilities alongside the ongoing proliferation of the virus, are just the kind of “risks” the Fed is concerned about.
The question is whether officials would prefer to go ahead and modify either the composition or the pace of QE next month to stay ahead of the proverbial game, or try to wait Mnuchin and Donald Trump out, knowing that Yellen is riding as fast as she can to this fight and should be arriving relatively soon.
The word “fiscal” comes up 18 times in the minutes — five times followed immediately by the word “policy.”
If you’re wondering whether anyone is worried about bubbles, moral hazard, or the possibly deleterious effects of preventing creative destruction from working its “magic” (and the scare quotes are there for a reason), the answer is:
A couple of participants expressed concerns that a prolonged period of low interest rates and highly accommodative financial market conditions could lead to excessive risk-taking, which in turn could result in elevated firm bankruptcies and significant employment losses in the next economic downturn.
But that’s a story for another day.
Finally, it’s worth noting that the Fed favors adopting guidance at some point which communicates that bond-buying will be tapered prior to any decision to raise the funds rate. That’s a given, but, again, worth a mention nevertheless.
Fantastic summary and interpretation!
Nearest, known near term risk is Mnuchin’s maneuver.
Barring an accident, a key takeaway is that the financial economy is in good hands.
Wouldn’t continuing to increase the WAM be a de facto form of yield curve control? Perhaps it’s not needed ‘at the moment’, because long yields are going nowhere as it stands, even with the FED intervening so dramatically in the TIPS market to try to force the inflation narrative to take hold.