More than ever, monetary policy is being dictated by the virus
As widely anticipated, the Federal Open Market Committee (FOMC) voted to maintain the current Federal funds target rate at a range of 0.00%–0.25% and the interest paid on excess reserves (IOER) at 0.10%. The decision was unanimous, with all ten voting members electing to leave rates on hold. In addition, the committee will maintain its current pace of gross purchases of U.S. Treasuries and agency mortgage backed securities at roughly USD 80billion and USD 90billion per month, respectively.
There were some notable adjustments to the FOMC statement itself. While the language suggests the committee views the economy may have bottomed in April, it continues to view the path of the recovery to be largely dependent on the virus. Even with the job gains experienced in May and June, and the improvement across the manufacturing sectors and broader financial conditions, the current levels of activity are still depressed relative to pre-COVID levels and therefore, policy will remain accommodative for the foreseeable future.
Much attention was paid to the press conference given there was some expectation on an update to the Federal Reserve’s (Fed) review of its monetary policy framework. Fed Chairman Jerome Powell did comment on the committee’s review, which focused on supporting expected and realized inflation outcomes with interest rates anchored near the zero-lower bound, but did not provide further details. However, Powell did mention the review would be wrapping up soon, setting up a potential policy announcement at the September meeting.
Elsewhere, Powell’s comments suggest the committee doesn’t seem to view inflation as a risk in the short term and that fundamentally, the social distancing shock has provided a disinflationary impulse on aggregate to the economy. They expect the economy to struggle against disinflationary pressures, rather than inflationary pressures for quite some time.
Asset purchases are expected to continue indefinitely given they are providing continued support to market functioning and the real economy. Notably, Powell did not dismiss the notion of some form of yield curve control being introduced at a later date. When asked about tying asset purchases to inflation or employment outcomes, he mentioned the committee was considering these options and that some guidance may be provided on this down the road. The Fed continues to be happy with its credit and lending facilities, but will keep them in place for some time, as evidenced by their extension to December 2020 earlier this week.
In summary, the committee is still very concerned about the path of the recovery given the leveling off of economic activity due to a resurgence in domestic cases. Therefore, as stressed in Powell’s comments, the recovery will depend on keeping the virus in check. With recent indicators pointing to some slowing in economic activity, a full recovery is unlikely until people are ready to engage in a broad range of activity. Markets took the news in stride with equity and bond markets relatively unchanged. For investors, the unprecedented monetary support from the Fed, combined with ultra-low interest rates may be enough to keep equity markets supported in the short term. However, the longer-term outlook for risk assets still largely depends on our success in mitigating the spread of the virus.