FOMC Preview: Standing pat but readying for action
No major changes to the FOMC statement are forecast as the previous statement downplayed the rapid rate of recovery and acknowledged the virus ‘poses considerable risks to the economic outlook over the medium term.’ Similarly, the guidance on QE should be kept the same with asset purchases maintained at the current purchase rate ‘over coming months’ and ‘at least at the current pace.’ These two phrases were only added in June and are not expected to be amended, even though QE has been tapered to around $4 billion per day compared to the $75 billion per day during the crisis peak.
Fed officials have made it clear that they will remain cautious, especially as markets await the outcome of negotiations over another fiscal stimulus. They believe the economy will need highly accommodative policy for several years and this is borne out in June’s dot plot, which showed just two FOMC members expecting any increase in the policy rate before the end of 2022. (The next summary of economic projections is scheduled for the meeting on 15-16 September). Most importantly, markets are currently buying into the low-for-longer story with the first hike not priced until late-2024.
Since the last FOMC meeting, we have seen a V-shaped recovery in the economy that has begun to stall in labour markets and across consumer activity. High-frequency data now suggests that the strong pace of improvement over the past couple of months may not last, even though the low point is probably behind us.
So while the first part of the crisis needed swift, historic measures like buying more than $2 trillion worth of Treasuries and Mortgage Backed Securities and an alphabet-soup of credit programs, the focus now turns from these emergency measures to ‘accommodation tools’, as several members of the FOMC have recently stated.
New tools to use
The key measure currently being discussed at the Fed centres around forward guidance. An outcome-based policy linked to inflation seems to be the most favoured, while a time-based guidance is least preferred. This would mean a shift away from pre-emptively raising rates before inflation got to the current 2% target, instead targeting that level and accepting bouts of above 2% inflation to make up for periods of sub-target inflation. By its very nature, this implies easy policy for a long period of time. Discussions around this so-called average inflation targeting were due to be completed ‘in the near term’ according to the June minutes, but many Fed watchers think this policy review needs more time to be debated and is more likely to be announced after the summer.
In making their forward guidance more dovish and outcome-based soon, talk of yield curve control (YCC), which is in itself a form of time-based guidance, may also be premature. Essentially, this policy would be used to reinforce that guidance and many of the FOMC members appear to need convincing of its effectiveness. In effect, YCC uses QE to target specific yields to prevent borrowing costs rising too quickly. but when the US 10-year is yielding around 60bps and the 30-year a mere 65bps more, there doesn’t appear to be an urgent need for this.
Stocks are currently bid for many reasons, but one is the expectation that forward guidance targeting inflation is a bullish sign. Obviously, this means that any delay in formal adoption might not be so encouraging. Interestingly that meeting is the last before the November Presidential election, although a Fed pause in policy action might be overhyped.
Currency moves are expected to be tame but a more sober assessment of reality, similar to what happened at the June meeting, could see riskier assets take a leg lower. This may also give a bid to the dollar which would see pullbacks in recent range breakouts in AUD and NZD, with the latter’s strength especially, garnering the attention of the RBNZ.