If the Fed wants to unveil plans to extend the average maturity of its ongoing asset purchases this week, Jerome Powell has more than enough excuses to lean on.
For one thing, Steve Mnuchin kneecapped Powell earlier this month, when he demanded the Fed return funding that supported key emergency facilities credited with stabilizing markets since the onset of the pandemic.
Mnuchin claimed he was just following “the law” and that the idea is to repurpose the funds by convincing Congress to allocate them as part of a virus relief package (or something). But some critics worried Mnuchin was playing saboteur — impeding the Fed’s capacity to stem a market rout and sequestering the funds away from Janet Yellen, all as part of a plan to undermine the incoming Joe Biden administration. To the extent that’s any semblance of true, I’d emphasize that Mnuchin wasn’t acting of his own volition. He may very well have been following “the law,” but in the dystopia that’s masqueraded as America for the past four years, Mnuchin’s boss took a Judge Dredd approach to matters concerning “law.”
In any event, that’s one excuse if the Fed wants to go ahead with WAM extension or some manner of enhanced forward guidance.
The other excuse is more straightforward: The virus is out of control in the US, with cases, fatalities, and hospitalizations all sitting at or near record highs on any given day. That’s prompted new containment measures to the detriment of economic activity.
Specifically, hospitalizations are approaching 110,000 nationally. Daily deaths are averaging around 2,300. It’s not uncommon for the US to lose 3,000 people in a single day to the virus.
As for daily cases, the situation is tragically absurd. By now, most Americans are desensitized to the figures, but I feel compelled to display an updated version of the chart nevertheless.
What you see below represents a complete and total failure on the part of the federal government to coordinate a top-down response.
The connection between those charts and the case for additional Fed accommodation is clear. The connection between those charts and the kind of accommodation the Fed will most likely lean on if and when they do turn even more accommodative is less so. And that is a critical distinction.
The unchecked spread of the virus is poised to dent the services sector, and that, in turn, may jeopardize jobs. Irrespective of what may or may not happen as a direct result of the winter wave, we know labor market momentum is decelerating. That was evident in the November jobs report and it’s also evident in jobless claims, although last week’s surge could have been distorted by a kind of “snapback” effect after Thanksgiving.
Analysts have generally trimmed their expectations for the US economy in Q4 and some see a contraction.
So, again, the case for some kind of stimulus is clear. And with Congress still dithering on the fiscal side with just days to strike a deal before the must-pass spending bill to which new virus relief would be attached needs to be cleared, the outlook is cloudy. Perhaps it will be less so by the time the Fed announces its decision on Wednesday. We’ll see.
As far as what monetary policy can do to ameliorate this situation, WAM extension would help ensure financial conditions stay accommodative and long-term borrowing costs remain low.
But here’s the thing. Financial conditions are already the easiest they’ve ever been. 10-year yields are below 1%, corporate bond yields are at record lows, the dollar is languishing near levels last seen in mid-2018, and equities are perched at record highs.
Given that, it’s not entirely clear whether now is the best time to deploy one of a dwindling list of available measures.
“The realities of the current stage of the pandemic (rising case counts and lockdowns) provide ample justification for such a move, as does the expiration of the muni and corporate liquidity facilities — regardless of utilization levels,” BMO’s Ian Lyngen and Ben Jeffery said, adding that “the flipside of the argument is that financial conditions remain extraordinarily easy and therefore keeping a WAM extension in reserve is the most prudent course.”
“We have our doubts that they will [unveil WAM extension] just yet,” ING remarked. “The 10-year yield remains below 1%, which isn’t exactly threatening.”
Of course, tamping down long-end yields isn’t just aimed at keeping financial conditions loose. It also helps facilitate the government borrowing “necessary” (and the scare quotes are there for a reason) to fund fiscal stimulus.
As ever, I have to speak in conventional terms. The reality is that fiscal stimulus doesn’t need to be “funded” through a ridiculous circular scheme whereby the Fed effectively dictates the rate and then buys debt from the folks across the street at Treasury using a collection of middlemen in an increasingly silly attempt to pretend like QE isn’t monetary financing. The obvious question is just this: If government is dictating the cost of borrowing in its own currency, buying debt from itself (at arm’s length), then spending the “proceeds” on stimulus, why not just forget the “borrowing” bit?
Anyway, we’re going to persist in the fantasy (and that’s what it is, folks: Pure fantasy) that the US government has to “fund” spending, so WAM extension from the Fed would help ensure the cost of funding stimulus stays low. But that only matters if Congress is willing to spend, and not everyone is on board with that, or at least not at levels many believe is necessary to provide the kind of support the economy needs.
Given that, you can expect to hear more exhortations from Powell regarding the necessity of fiscal stimulus, even if Congress agrees to another relief bill this week. Looking out to 2021, Republicans will try to hold the line on more stimulus, but that’ll be a tall order. Assuming the GOP holds the Senate, McConnell will be under pressure from Nancy Pelosi, Joe Biden, Yellen, and Powell to adopt additional fiscal measures.
Another option for the Fed this week is enhanced forward guidance around asset purchases, where that would likely mean tying them to the achievement of inflation and labor market outcomes in the same way the FOMC’s rates guidance is now outcome-based. That might be preferable to WAM extension in the near-term, as it gives the Fed a way to lean dovish without actually doing anything. Recall the November minutes showed officials spent quite a bit of time discussing the communications strategy around QE going forward.
“At the last FOMC meeting of the year, we expect no policy changes from the Fed but ‘qualitative outcome-based guidance’ that links asset purchases to economic conditions,” SocGen’s Subadra Rajappa said, in her last fixed income weekly note of 2020. “After a tumultuous year, one for the history books, hopefully the wild ride ends here,” she added.
I’m sure the Fed is thinking the same thing.