Headed into the last FOMC meeting of the most tumultuous year in modern history, Fed officials had a decision to make.
To their chagrin, that decision involved more than simply thumbing through a thesaurus to decide which adjectives to use in the statement and whether to shuffle around a couple of dots on a meaningless “plot” that nobody outside of finance cares about, let alone understands.
Rather, thanks to the expected economic impact of surging COVID-19 cases and associated containment protocols in the US, and at least in part because Steve Mnuchin decided to remove some key tools from Jerome Powell’s kit earlier this month, the Fed was compelled to ponder whether to extend the maturity profile (“WAM extension”) of its asset purchases in order to make them more “stimulative.”
Read more: Let Me Off This ‘Wild Ride’: What To Expect From The Fed’s Last Meeting Of 2020
Another option was to strengthen the forward guidance around QE, making it outcome-based in the same way the committee’s rates guidance is now tied to the achievement of specific economic milestones.
The quandary, of course, is that 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 near record highs.
So, despite the clear and present danger posed by the virus and associated lockdowns, and while acknowledging that labor market momentum has decelerated meaningfully over the past month or two, the Fed needed to assess whether WAM extension was a tool best left in reserve.
Complicating matters was the ongoing stimulus stalemate on Capitol Hill where, by Wednesday afternoon, it was some semblance of clear that a deal was finally coming together after five agonizing months of headline hockey.
It’s fair to say there was no “consensus” on whether the Fed would or wouldn’t go ahead with WAM extension Wednesday. Ultimately, the FOMC decided to hold off, opting instead to enhance its forward guidance, although I’m not sure “enhance” is the right word for what the committee delivered.
The Fed “will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals,” the December statement reads. That’s a modest upgrade from the previous “over coming months” language.
“This isn’t a hard target for when one might expect QE to be scaled back, even if the introduction of bond purchases to the forward guidance language is a clear indication it’s here for the long haul,” BMO’s Ian Lyngen said.
Although the Fed obviously wants to engineer a “healthy” level of inflation (now by tolerating overshoots to compensate for persistent shortfalls), the idea is to do so without accidentally triggering a disorderly bear steepening episode.
In addition to upending a decade’s worth of duration-liked trades embedded across assets, higher long-term borrowing costs cannot be countenanced at a time when the US is borrowing to fund stimulus. (And I’ll resist the temptation to remind you that this entire charade is everywhere and always couched in misnomers and discussed in terms that don’t reflect the realities of government financing for a currency-issuing sovereign, let alone one that issues the world’s reserve currency.)
To be sure, many traders are sitting on a core steepener in light of expectations for more Treasury supply and the purportedly inevitable inflationary “payback” from “money printing” and various manifestations of fiscal and monetary largesse. Shorts in the long-end are stubborn. And yet, despite the recent pro-cyclical rotation which has seen small-caps and value (for example) outperform, all manner of trades are still tethered to the yearsold “duration infatuation” in rates.
So, it’s not just that the Fed needs to keep borrowing costs low. Central banks also want to be mindful of the potential for a disorderly bear steepening episode to force an unwind across, for example, still-crowded secular growth stocks that until very recently shouldered the burden of sustaining the equity rally.
All of these concerns, together with the desire to ensure already ultra-loose financial conditions remain that way, are part and parcel of the discussion around why the Fed wants to exert a measure of control over the long-end of the curve. Hence expectations for WAM extension and/or the explicit linking of QE to economic outcomes. On Wednesday, the market got a watered down, vague version of the latter.
Speaking of economic outcomes, the December statement found the Fed adopting the same cautious tone from previous statements, unchanged. “Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year,” the Fed said. “The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” There’s nothing new there — nothing at all.
Five officials see a hike in 2023. The growth outlook was revised higher from the September projections, and the unemployment forecasts lower. The latter essentially represents a marking- to-market, as it were. Inflation projections were nudged barely higher for 2021 and 2022, but remain below target (1.8 and 1.9, on headline and core).
Frankly, it’s hard to see how this is anything other than a disappointment. On a first read, the Fed delivered little more than a tweak to the statement language around QE, and even that tweak was far from aggressive.
I suppose it’s possible to suggest the “substantial” language around the progress necessary to force a taper gives the Fed a lot of optionality, but I doubt the market will be inclined to adopt that generous interpretation.
Full December statement
The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.
The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world. Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year. Weaker demand and earlier declines in oil prices have been holding down consumer price inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.
The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.
December dots
December SEP
