Monetary Medicine until the Patient is on the Mend
Adopting his best bedside manner, Federal Reserve (Fed) Chairman Jay Powell, assured investors today that the Fed would do everything in its power to weather the current crisis and set the economy on the road to recovery.
As anticipated, the Fed maintained the current Federal funds target rate at a range of 0.00%–0.25% and maintained the interest rate paid on excess reserves at 0.10%. The decision was unanimous, with all ten voting members electing to leave rates unchanged. The language in the Federal Open Market Committee (FOMC) statement was decisively dovish, yet broadly in line with expectations. The Committee acknowledged the steep declines in economic activity, surge in job losses and the collapse in oil prices, as all severe consequences of the social distancing efforts put in place in order to combat this public health crisis.
Perhaps somewhat surprisingly, the Committee essentially dismissed the idea that it would consider lowering rates into negative territory, stating it “expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”. In our view, this is both a nod to the perceived ineffectiveness of negative rates as experienced in Europe and Japan, but more so recognizing that lower interest rates in the current environment will do little to spur economic activity so long as social distancing measures remain in place.
During the press conference, Chairman Powell discussed the Fed’s perspective on balance sheets and the broad use of its various lending facilities. On the balance sheet, the Fed has purchased an incredible amount of Treasury and agency mortgage-backed securities (MBS) over the past six weeks, ballooning the overall asset portfolio by USD 2.3trillion. Interestingly, the committee views these purchases through a dual lens: providing an easing of financial conditions to the broader economy and restoring market functionality in Treasury and mortgage markets. On the latter point, functionality has improved and this will allow for the Fed to slow the pace of purchases in the coming weeks, however, the committee seems well prepared to increase purchases again should it deem necessary.
Elsewhere, many were hoping for additional forward guidance on the “alphabet-soup” list of lending facilities, but it’s important to note that most of the Fed’s credit support programs are authorized by the Fed Board, not the FOMC. Therefore, very few details were shared in that regard, except that we should expect the corporate credit and main street lending facilities to be up and running fairly soon. Importantly, however, Powell emphasized that the committee will continue to use the full range of its tools and, if necessary, can—and likely will—either establish new facilities or expand the size of the current facilities. From a technical perspective, the Treasury still has more equity capital to lend and this gives the Fed ample room to increase the scope of monetary stimulus.
The Fed remains committed to ensuring the proper functioning of bond markets and that credit can get into the hands of necessary borrowers. The dovish tone struck, suggests interest rates will likely remain lower over the medium-term. Markets digested the news in stride with equity markets moving higher and bond yields 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.