FOMC Preview: Will the Fed do more to lift markets?
The Fed convenes for its first scheduled two-day monetary policy discussions since the emergency meetings last month which addressed the market turmoil caused by the Covid-19 pandemic. The two previous statements written on March 23 and 31 are no longer timely assessments so will need to be rewritten and full forecasts, which would normally have been delivered last month, may not be released until the next scheduled round in June.
Last month, the Fed announced an extraordinary array of measures to combat the virus. Besides cutting rates to near-zero, eleven facilities have been created or expanded, which reveals the scope and scale of the shock. Lessons have certainly been learnt from the GFC as the Fed has acted quickly in implementing the 2008 playbook, as well as rolling out more controversial programs, some of which have yet to start.
This includes the recent credit bazooka which will provide up to $2.3trillion in loans to small and mid-sized companies (including ETFs), named the Main Street Lending Programme. This will allow the Fed to buy recently downgraded high-yield bonds, the so-called ‘Fallen Angels’, and should have the biggest immediate impact on the real economy as most of the jobs created in the US economy are among small businesses.
It also adds to the moral hazard story as the Fed becomes the bank of last resort for the whole economy, not just for the banking sector. The market will be keen to hear when these facilities will get under way and the implications for the Fed’s balance sheet, which is set to increase dramatically relative to GDP.
The FOMC is expected to confirm stable interest rates for the foreseeable future. Markets have priced out any changes over the long-term so the March 15 guidance around the Fed maintaining the current target range until it's ‘on track to achieve its goals’ could be strengthened, as this is now somewhat dated.
We may also see a hike in the interest the Fed pays banks on excess reserves (IOER), if only to get market rates further away from going negative and toward the middle of the 0-0.25% range. The last available minutes of the March 15 meeting contained clear indications that negative rates are not seen as an option.
More to come?
Any guidance as to where the Fed still sees signs of strain, even as trading conditions broadly stabilise, will be a focus. More than half of the emergency backstop lending (around $260bn) is still available to the Fed which has increased speculation that they are looking at other parts of the credit markets – could the Fed start buying equities or commodities? Powell himself hinted in early April that “we won’t hesitate to move into other (security) areas” and the latter would undeniably increase inflation expectations.
Yield curve targeting may also get some airtime with more central banks recently adopting this tool. For example, the RBA focused on the 3 year bond yield while the BoJ fixates on the 10 year JGB. That said, the benefits at this point seem to be fairly subdued and there's also the likely negative impact on the banking sector.
Minimal market implications
Aside from some minor tweaks to operational areas, it could be a relatively quiet scheduled meeting given the recent market stabilisation and the ongoing support. Powell should repeat the Fed’s views that the measures will stay in place until a recovery is certain. The dollar is then likely to get hit hard, but this is obviously some way out. Before then, credit spreads should narrow further and the curve steepen due to the budget deficit blowing out.
Of course, keeping its options open does mean the ‘Fed put’ remains in play for stock markets and this is a dilemma that the FOMC will need to address going forward.
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