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Fed Issues Loose Guidance

RFP
The Federal Open Market Committee (FOMC) concluded its two-day meeting with a whimper. Members voted unanimously to keep interest rates low and approved very loosely worded guidance on asset purchases. They have signaled that they will continue the current pace of $120 billion per-month pace of Treasury bond and mortgage-backed securities until we see “substantial further progress...toward the Committee's maximum employment and price stability goals.”

The FOMC also released its quarterly forecasts and risk assessments. The drop in growth in 2020 is now less severe than it was in September, while the outlook for growth is more bullish. Having a vaccine on the horizon matters. Even the forecast on inflation moved up a bit, but remains below the Fed’s 2% goal through 2023. The number of participants who expect a rate hike in 2023 went up by one to five. That suggests that there is still considerable debate over the path of inflation going forward and how long the Fed should tolerate an overshoot.

The FOMC has stated that its goal is to allow for some modest inflation if it drives unemployment lower and wages higher. However, participants have yet to come to a firm consensus on what that actually means in practice. The only thing that is clear is that the Fed will tolerate a modest overshoot, not a flare in inflation. The trajectory for inflation matters.

Powell addressed questions about a temporary flare in inflation tied to a surge, once we hit herd immunity. He said the Fed would see any supply shocks triggered by the crisis as transitory. A temporary surge in prices would not prompt the Fed to raise rates.

Risks as laid out by participants have become more balanced instead of to the downside. Again, this reflects optimism regarding a vaccine, the prospect of herd immunity and a broader reopening of the economy. The Fed has been surprised at the persistence of spending and economic activity given the severity of the surge in COVID cases and hospitalizations. We are not as skittish as we were about getting COVID than we were at the onset of the crisis.

Fed Chairman Jay Powell emphasized optimism about a vaccine but cautioned about the high level of uncertainty. The next few months are likely to be “very challenging.” There is concern about the timeline on vaccinations. The logistics of getting so many people vaccinated are complex. (Understatement.)

Powell underscored the need to continue to provide support for credit markets. The Federal Reserve would not hesitate to increase the size of its balance sheet to provide more support if needed. Powell emphasized that the Fed could work with Treasury to reopen lending facilities that Treasury Secretary Mnuchin decided to close at year-end.

Powell repeated his mantra that the Fed can lend, but not spend. That was yet another plea to Congress to get another COVID relief bill done, which looks possible.

Why didn’t the FOMC do more at this meeting? Powell was tentative in his answer to this question. The minutes to this meeting are likely to reveal some colorful debate on the issue of additional asset purchases. Many participants entered the meeting with strong opposition to additional purchases at this phase of the recovery.

Powell was the most uncomfortable that I have ever seen him in a press conference. The prospects for a vaccine have clearly split the FOMC. Some are more optimistic about what that means for the economy and support needed from the Fed. The consensus on the need for relief by Congress to get through the next “four to five months” is high.

Powell assured his audience that there is more the Fed can do. He mentioned only that the Fed can purchase more assets and extend the maturity of assets purchased. That was despite a reluctance to commit to extend the duration of asset purchases today. He is clearly more comfortable doing that than some of his colleagues.

Powell also laid out the breadth of the pain so many households are enduring. He has shown more empathy for what is happening on Main Street than we have ever seen by a Fed Chair. He is more worried than some of his colleagues about the long-term damages triggered by the crisis. His empathy and lack of economic jargon is welcome news. I worry that the message could get lost in translation, given his own admission that the Fed is ill-equipment to cure what ails us; that is better left to fiscal policy.

Powell was stronger in his defense of the Fed’s role in dealing with climate change. The Fed recently joined 80 other central banks in looking at the impact of climate change on financial conditions. Climate change is an emerging risk that could materially affect the credit quality on bank balance sheets.

Bottom Line
The FOMC did very little at this meeting. Chairman Powell was clearly more concerned about near-term losses than his colleagues. The question comes down to whether the pent-up demand unleashed once we reach herd immunity is enough to lift all boats. He is not convinced; neither am I.

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