The Fed has positioned itself in such a way that its next move seems obvious and that it will ease policy further by some means sooner than later, with sooner being the December FOMC meeting. Expectations are moving in the direction of the Fed shifting asset purchase toward the longer end of the curve. Not to be outdone, some shops are expecting the Fed to increase the pace of asset purchases.

I am not terribly comfortable with this narrative yet. I could get comfortable with it under certain circumstances, but I have some nagging doubts. Here I am going to outline those doubts and hopefully provide some context for thinking about this issue.

I think we can consider these six facts as central elements to the growing narrative:

1. As in the last cycle, the Fed’s forecasts predict that inflation will remain belong target for a protracted period of time. This suggests that the Fed should take further action to support the economy and accelerate the return to target. They have so far opted not to do so but presumably could.
2. Fed officials have repeatedly expressed concerns about the dual downside risks of a Covid-19 surge and insufficient fiscal support. Both of those events look more like reality than risks.
3. The Fed has repeatedly expressed concerns about inequalities and permanent job loss arising from the pandemic recession. Federal Reserve Chair Jerome Powell reiterated these points in remarks yesterday. There seems to be no point in complaining about such issues yet still hold policy steady.
4. The Fed believes their tools remain effective. On Monday Federal Reserve Vice Chair Richard Clarida used the strength in interest rate sectors of the economy as evidence that monetary policy was as effective in this cycle just as it has been in past cycles.
5. Federal Reserve Governor Lael Brained said in October that “in the months ahead, we will have the opportunity to deliberate and to clarify how the asset purchase program could best work in combination with forward guidance to support achievement of maximum employment and 2 percent average inflation.”
6. With interest rates at zero and the Fed dismissive of yield curve control, the primary tool available to the Fed is the asset purchase program. The Fed discussed possible extensions of the asset purchase program at the November FOMC meeting.

The path from that set of facts to some type of action at the December meeting seems straightforward. So what’s eating at me?

First, I don’t know entirely how to interpret Powell’s dovishness. I think Powell is rightly concerned with saying anything that can be interpreted as optimistic out of fear that doing so will lead market participants to erroneously conclude that the Fed is closer than expected to hiking rates. He is genuinely committed to sustained accommodative monetary policy because even if the U.S. recovery remains intact this winter, the economy will still be in a hole with excessively high unemployment. I don’t think he wants to accidentally blunder into a “taper tantrum” and slow any progress toward meeting the Fed’s goal.

That said, if Powell is indeed concerned about things like inequality or long-term labor market damage, why hasn’t he already pushed his colleagues into expanding the pace of asset purchases? The situation now is no different than two or three months ago. I can really only conclude that he views monetary policy as a poor substitute for fiscal policy at this point in the cycle and to achieve his desired goals. A very poor substitute. When Powell says the Fed has reviewed the asset purchase program and concluded that it is providing the appropriate amount of accommodation, he may really be saying that increasing it will neither accelerate the recovery nor deal with the structural issues that concern the Fed. Why then would they do something in December that they have already concluded won’t help?

While Powell may be suppressing optimism, Clarida, let the optimism fly as he revealed that the good news on the vaccine gave him:

 “…more conviction in my baseline for next year and more conviction that the recovery from the pandemic shock in the US can be potentially more rapid, potentially much more rapid, than in was from the Global Financial Crisis…there is an enormous quantity of pent-up saving….so you combine the good news on the vaccine with north of a trillion dollars of accumulated saving, the there is a very, very attractive right tail to this distribution.”

Could Powell see more upside risk than he is willing to admit?

Second, the Fed has not identified how the asset purchase program interacts with the Fed’s new strategy. The path of the asset purchase program and its relation to economic outcomes has not been tied down as has the path of interest rates. This is what Powell said at the November press conference:

EDWARD LAWRENCE. Thank you, Mr. Chairman, for taking the question. So what would cause the Federal Reserve to shift more of its asset purchases towards the long-term securities and Treasuries and change the amount of spending there also? And as a second point onto that, you know, would — if there’s no fiscal stimulus package, would that then trigger buying of more long-term assets or change the asset purchases?

CHAIR POWELL. So I don’t really have a specific hypothetical I would put to you. I would just say that we understand that there are a number of parameters that we have where we can shift the composition, the duration, you know, the size, the life cycle of the program. All of those things are available to us as ways to deliver addition — you know, more accommodation if we think that’s appropriate. Right now, we like the amount of accommodation the program is delivering. And it will just depend on the facts and circumstances. We may reach a view at some point that we need to do more on that front. Today’s meeting was about analyzing the — one of the things it was about was about analyzing the various ways and having a, you know, good discussion about how to think about those various parameters, which I thought was quite a useful discussion.

What are the “facts and circumstances” that were discussed? We don’t know. We are falling into the assumption that the “facts and circumstances” include addressing the negative impacts of a Covid-19 surge, but we don’t know that. Again, it appears the Fed already concluded that increasing the changing the asset purchase program would not accelerate the recovery, so why would they believe it could offset fresh pandemic weakness?

There is one obvious set of “facts and circumstances” that would prompt the Fed to alter the asset purchase program: A financial disruption. And that gets me to my third concern. I am pretty sure that a financial hiccup would get the Fed’s attention and provoke a response. As of yet, however, there has been no financial disruption despite the surge of cases across the nation.

The financial situation appears very different from this past spring. Then the markets quickly discounted the implications for the economy and the stocks crashed while credits markets nearly froze. This time no such thing has occurred. Why? A number of possibilities. First, this is “lockdown light” that will have less significant economic impacts. Second, selling off is foolish because we know there will be a rebound on the other side. Third, market participants are looking through the short-term problems to the long-term solutions.

Whatever the reason, financial markets are not tightening. Now, to be sure, longer term interest rates are edging higher, but that increase could be consistent with improving economic conditions, so it is not readily obvious the Fed would need to push back. This from Clarida this week was illuminating:

We are buying a lot of Treasuries, we’re buying $80 billion a month, that comparable to the path of QE2 and it’s roughly the duration pull…with long-term yield at historically low levels and below both current and projected inflation, financial conditions are accommodative…not concerned about the rise in Treasury yields and it is still in an accommodative range.

Those are not the words of someone interested in expanding asset purchases or changing the duration of the program to sit on the long end of the curve.

Bottom Line: I don’t know that the Fed’s behavior with regards to the asset purchase program to date argues for change in the composition of purchases as a response to feared renewed pandemic weakness. If the Fed believed alterations to the program would have a meaningful impact on economic outcomes in the current environment, they should already have changed the program. That outcome though seems more likely than expanding the pace of asset purchases. Another possibility is that the Fed decides to clarify the length of the program to make is consistent with guidance on the interest rate. This seems like an easier call than other options. The most likely reason to alter the asset purchase program would be to offset a tightening in financial markets, but as of yet that doesn’t seem necessary. Hopefully the upcoming minutes of the November FOMC meeting will reveal new information and the Fed’s discussion of the asset purchase program.