The Federal Open Market Committee (FOMC), the policy setting arm of the Federal Reserve, concludes its two-day meeting on November 5. The FOMC statement following the meeting is expected to underscore downside risks to the outlook given the recent surge in COVID cases, renewed lockdowns in Europe and failure by Congress to deliver on a new aid package.
Many members of the FOMC were counting on a substantial new aid package to help the economy weather the winter. Minutes to the September meeting revealed that many on the Fed are growing concerned about a potential wave of defaults dealing a blow to the stability of the financial system in the months to come. We have long argued that the FOMC will announce a new round of asset purchases in December to do what it can to shore up the economy. Look for the Fed to prep the public and financial markets for an expansion of asset purchases at the conclusion of the November meeting.
FOMC members have discussed expanding the current asset purchase program, which includes $120 billion in mortgage-backed securities and Treasury bond purchases. They can extend the duration of Treasuries to better anchor long-term bond yields and increase volume. They can also use regulatory powers to ensure banks are better capitalized. The Fed already extended restrictions on dividends and share buybacks by the 100 largest banks.
The Federal Reserve is conducting another round of bank stress tests now, the results of which are due before year-end. Banks will no doubt have to shore up their capital buffers given defaults and the reluctance of Congress to act on another aid package. Commercial real estate has been hit particularly hard by defaults.
At its last meeting in September, the Fed moved to clarify language allowing for more of a modest overshoot in inflation before a rate rise. Two members of the FOMC voted to dissent on that change in language: One argued it was not necessary; the other said the shift in language did not go far enough in describing the decision rule for a rate hike. This underscores the lack of consensus about the rules regarding future rate hikes and the limits that FOMC members fear they are reaching in their efforts to do more to help an economy still struggling with COVID-19.
Look for Chairman Jay Powell to clarify the emerging consensus on additional asset purchases during the press conference. He will also underscore his plea for more fiscal stimulus, given the mounting headwinds associated with the surge in COVID cases, hospitalizations and deaths. He and others on the Fed have been consistent in their view that the course of the virus determines the course of the economy, and that households and businesses are suffering “through no fault of their own.” (This crisis is unique. Concerns about moral hazard need to be shelved.)
This week the Fed’s limits in dampening COVID-related losses will be tested. Financial markets are finally becoming concerned about the uncertainty created by the election.
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