Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):
After cutting rates by 150bps to the zero lower bound at two unscheduled meetings, re-starting quantitative easing and launching a variety of liquidity and credit facilities with capacity of more than 2 trillion dollars, the Fed is now back on a regular schedule. While the FOMC statement needed major revisions to the economic assessment, there were no new policy announcements made at this meeting or adjustments to the Fed’s forward guidance regarding asset purchases or interest rate policy at the zero lower bound. The tone of statement reflected the high level of uncertainty regarding the future path of the economy embedded in a dependency on healthcare outcomes. Given this uncertainty, there was a strong recognition that the medium-term risks are currently very elevated.
At the press conference, Chair Powell communicated the Fed’s willingness to be flexible and highly devoted to using all of the Fed’s tools to support the economy. Without providing specificity, Chair Powell communicated that the quantitative easing program and low interest rate policy would remain in place as long as needed to help the economy withstand the drawdown in activity as a result of COVID-19 health crisis.
There were no dissenters at the meeting.
We can break the statement into two parts:
- Economic Assessment –The economic assessment was significantly downgraded to reflect the bleak reality of the fundamental situation the US now faces. The Fed highlighted the “surge” in job losses in light of the over 25 million in initial jobless claims reported over the past five weeks as well as the collapse in oil prices.
- Outlook – The Fed is continuing to monitor the incoming information on public health, the jobs market and inflation. They have committed to maintaining easy monetary policy as long as needed to support the economy through the public health crisis and the recovery. The Fed flagged medium term risks as elevated, which reaffirmed the need to stay very accommodative at low levels for a long time.
Chair’s Press Conference
At the Press Conference, there were a few questions on the new facilities the Fed has announced over the months of March and April as well as the expectations around the quantitative easing program. The asset purchase program was first announced on March 15th as a 700bln program and shifted to an unlimited program on March 23rd. Chair Powell emphasized flexibility regarding the future pace of QE but indicated they were happy with the program as it stood today given the current conditions. He provided himself similar flexibility to adapt and expand its credit and liquidity facilities with willingness to coordinate with the Treasury. He gave no firm dates on when all the programs would be up and running. He indicated that the Corporate Credit facilities would be up and running soon but the Main Street Lending Facility would take more time.
Beyond near term policy questions, there were also questions on additional tools the Fed could consider if the economic environment does not improve. Chair Powell emphasized that the Fed had more tools available and would take whatever actions necessary within the context of their legal authority. He did not express a preference for a particular tool such as negative interest rates, yield curve control or more explicit forward guidance.
There were a few questions related to moral hazard. The Chair recognized the Fed was taking on more credit risk then in the past but believed it was appropriate given the public health crisis and supported by capital for losses and approval by the Treasury. The Chair noted that monetary policy and lending facilities are meant to address liquidity at solvent institutions but the Fed is not designed to create spending programs or provide grants such as the PPP. He stated that because the Fed is legally only allowed to lend to solvent institutions that only Congress can provide spending support to address bankruptcy risks which are rising for households and businesses.
Finally, the Chair was asked to address the economic outlook and the expected length of the recovery. He expressed caution specifically related to the potential for damage to the productive capacity of the US economy. A decline in the productivity of the US economy could occur if workers lose skills or can’t regain employment as well as the destruction of small and medium size businesses if they are not able to get the needed liquidity to remain afloat. The Chair acknowledged that it is likely that both more fiscal and monetary stimulus may be needed at some point to help promote the recovery.
- We expect the Fed to keep policy rates at the zero lower bound for the foreseeable future and continue their asset purchase program through at least the end of the year purchasing a total of more than USD 2.5 trillion in Treasuries and USD 1 trillion in Agency MBS. The continued fast pace of balance sheet expansion will help maintain liquidity in the Treasury market especially as supply begins to pick up to fund fiscal aid.
- We expect the improvement in Treasury liquidity will allow US yields to trade in a moderate range with less volatility than at the start of the year. We expect the 10yr Treasury yield to trade in a range of 0.5% - 1.0%.
- We anticipate that the Fed’s announced and expected programs will be successful in promoting market liquidity but will struggle to offset the shock to real economic growth even with the government aid already announced. Solvency and defaults remains a meaningful danger to the real economy as well as the valuation of credit markets. We expect the unemployment rate to surge in the coming months above 15% only to give way to a slow recovery where the level of employment may not fully recover back to Q4 2019 levels for multiple years.