Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):
The FOMC voted to maintain the Fed Funds rate at the zero lower bound. The tone of statement continued to reflect the elevated level of uncertainty regarding the future path of the economy, which justified the Fed’s decision to maintain a high level of monetary accommodation.
At the press conference, Chair Powell communicated the FOMC’s on-going pursuit to promote employment, growth and inflation using the full extent of the Fed’s toolkit. Chair Powell communicated that the Fed’s quantitative easing program and low interest rate policy would remain in place as long as needed to help the economy recover back to the Fed’s dual objectives. He also indicated that fiscal policy would be crucially important to promote the recovery as the Fed’s power allows them only to lend and not to spend. Chair Powell also indicated the Fed was discussing additional policy options such as yield curve control.
The FOMC released the Summary of Economic projections for the first time since December 2019. For the time being, the SEPs will serve as the principal means to communicate forward rate guidance. The median of the committee expects rates will be at the zero lower bound through the forecast horizon of 2022.
There were no dissenters at the meeting.
We can break the statement into two parts:
- Economic Assessment – The economic assessment was little changed. The Fed did not mention the strong May jobs report likely viewing one month of improved data with some level of caution given the unprecedented uncertainty associated with the COVID crisis. The one upgrade to the outlook was reflecting easier financial conditions.
- 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. After having tapered asset purchases for the past few weeks, the Fed committed to maintain the current levels of Treasury, Agency MBS and Agency CMBS purchases indefinitely with a promise to do more if necessary. The current pace stands at 80 billion per month in U.S. Treasuries, 40 billon net (96 billion gross) per month in Agency MBS and 1-2 billion per week in Agency CMBS. The Fed continued to flag medium term risks as elevated, which reaffirmed the need to stay very accommodative at low levels for a long time.
Summary of Economic Projections
Investors received participant’s outlook for growth, inflation, employment and policy rates expectations over the next few years for the first time in 6 months. Growth is expected to be particularly weak this year with a significant rebound in activity over the next two years. The Fed did not believe long-run growth was materially impaired by the Covid-19 shock. FOMC participants are a bit more optimistic about the rebound in labor markets expecting a substantial retracement in job losses by 2022 back to 5.5%. Finally, the Fed’s median expectation for inflation will be significantly below the 2% target for next few years. As such and in support of its forward rate guidance, the Fed projected the Fund rate to be at the zero lower bound for the next 3 years.
Chair’s Press Conference
At the Press Conference, Chair Powell was questioned on a variety of topics. He re-iterated that the he believes that monetary policy is well placed at the current time. There were a number of questions on the Fed’s forward guidance. Chair Powell indicated they are reviewing all options including receiving a briefing on foreign central bank experiences on yield curve control.
On the state of the recovery as state economies re-open, Chair Powell was cautiously optimistic on the improvement shown in the May jobs report but there was a long road ahead for the recovery. He mentioned that despite the welcome upside surprise that it would still take a long time to return to full employment and accommodative policy would be necessary to support the recovery. He also indicated that accommodative policy would reduce the likelihood of longer run damage to the economy.
In terms of the Fed’s commitment to keep rates low, Chair Powell was very firm suggesting that even if the data surprised on the upside that low inflation would predicate a need to keep rates low. He recognized the Fed was not able to get inflation sustainably back to target in the last cycle and he would like to make sure policy remains easy for long enough to promote that objective more sustainably.
On the Fed’s credit and liquidity facilities, Chair Powell discussed the tweaks on the Main Street Facilities announced to make the program more accessible and successful as well as the next steps to get the program up and running.
- 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. In addition, we expect the Fed to introduce additional forward guidance in the second half of the year. This will most likely be a version of yield curve control focused on the 3-5 year part of the curve.
- We expect the Feds’ purchases of Treasuries and strong forward guidance will allow U.S. yields to trade in a moderate range with less volatility than at the start of the year. We expect the 10 year 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 fully 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. In addition, we expect the unemployment rate to remain elevated and only slowly recover.