Fed Likely to Talk About More Policy Tools Today
Investors will mark time until 2:00pm ET when the FOMC releases its post-meeting statement. While the statement will probably be a fairly mundane affair without too much to surprise the market, more attention will be paid to the post-meeting press conference with Fed Chair Powell. While there isn’t any monetary policy dial-twisting expected today, the market is looking for what is to come down the pike in regards to possible additional policies and forward guidance. While most Fed watchers think they’ll be at the zero-lower bound well into next year, if not beyond, it’s some other policy tools that they haven’t used yet that the market will be looking to hear about this afternoon. We go into a more detail on those items in the section below.
One of the two mandates given to the Fed is price stability and in the last ten years or so, that has not meant controlling the rise of inflation as much as trying to get inflation up to a level that is deemed most beneficial to the economy. The benchmark used by the Fed has been 2% core inflation but it’s been mostly a futile exercise in trying to lift the core rate to that level, or above. The global recession/depression brought on by fighting the coronavirus will only make that chore even harder. This morning, May CPI was released and missed to the low side of expectations. Both core and overall were down –0.1% for the month versus 0.0% expected. The year-over-year number was 0.1% overall versus 0.3% expected, while core was 1.2%, the lowest since 2011. The graph of the two measures is below.
With the trillions in fiscal stimulus provided by Congress, and the multitude of special lending programs instituted by the Fed and its lower-for-longer monetary policy, expectations are that inflation is likely to start bubbling to the surface, but that’s probably a 2021 story, at best. What’s more, the other part of the Fed’s mandate is full employment and with unemployment at 13% to 16% (depending on the level of errors the BLS has identified in their monthly surveys), we’re a long way from full employment and not likely to get there for many years. That means the Fed, with inflation currently well under it’s 2% benchmark, and full employment years off, the period of rates at the zero lower bound seems likely to continue for a couple more years, at least. And with other tools at the Fed’s disposal, like yield curve caps, long rates seem destined to spend plenty of time at these lower levels as well.
What to Look for From the Fed Today
While the Fed is not expected to twist any dials on the monetary policy control panel today, the press conference will provide a platform for Chair Powell to expound on some additional tools that are still in the tool box which might be brought out at some point this year. Also, this meeting should include a resumption of the Fed’s Summary of Economic Projections and Dot Plots. While any type of forward looking analysis in this environment is filled with uncertainty it will be interesting to see where the Fed projects rates and the economy to go. Here are several items we look forward to seeing and/or hearing about in today’s meeting.
- Forward Guidance-this is the Fed’s best estimate of when and where they see rates headed in the short and medium term. Given the profound economic dislocation that the U.S. and world economies have suffered, it’s likely the guidance will be another lower-for-longer period that could easily stretch into years. Just knowing the Fed stands to keep short rates near zero and quantitative easing stands ready to absorb long-end back-ups, should give markets some certainty that the Fed will remain accommodative for a very long time.
- Summary of Economic Projections (SEP) and Dot Plots Return-The last time the Fed ventured a SEP and Dot Plots was the January 29 FOMC meeting, right before the wheels came off of the global economy. Since then it’s been more about putting out fires and instituting emergency lending programs rather than the somewhat academic exercise of plotting a best guess on the economy and rates. With today’s meeting, however, the SEP and dot plots return and if nothing else it will make for interesting reading where Fed members see GDP, inflation, and unemployment ranging over the next several years. Also, the surprising May jobs report might provide a decent bit of dispersion to the dot plots and where members see the fed funds rate over the next few years as we attempt to bounce back from the virus lockdowns. The median rate, however, is likely to remain near zero well into next year, and beyond.
- Yield Curve Caps– One thing we’re likely to hear about today, but not put into place, are yield curve caps. This is another way to control yields at a certain point on the curve. For instance, the Fed may want to keep the 10-year rate below 1.25%. If the yield begins approaching that level the Fed would begin buying the 10-year in enough quantity to keep the yield below 1.25%. This approach was tried in the 1940’s fairly successfully and most recently by Japan. While it’s not expected that the Fed will initiate such a policy today, expect that it will be mentioned and discussed in the press conference.
- Negative Rates– Expect negative rates to be brought up again in the press conference but expect Chair Powell to swat it away as he has every time before the issue has been brought up. It’s probably safe to say of all the tools in the Fed’s tool box, negative rates would be the last to come out, and if it did it would probably be a signal that we’ve used up just about every other tool in our disposal.
Agency Indications — FNMA / FHLMC Callable Rates
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