The December FOMC meeting concluded largely as expected with the Fed providing some additional guidance around the asset purchase program but declining to make changes to the program at this time. During the presser, Federal Reserve Chair Jerome Powell made clear that the Fed believes it is currently providing sufficient accommodation to support the recovery, he finds it unlikely that changing the asset purchase program will have a substantial impact on the time required for inflation to return to target, that the problem facing the economy is a near-term issue that can’t be effectively addressed with monetary policy, and that fiscal aid is the best (only?) tool that can address the economic impact of the current surge of Covid-19 cases.
That said, despite the Fed’s failure to change the asset purchase program this was still a dovish result. Four points to keep in mind:
- The description of the economy was unchanged and focuses on the level of the economy not recent growth:
The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world. Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year. Weaker demand and earlier declines in oil prices have been holding down consumer price inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.
The Fed doesn’t want market participants to focus on the pace of the recovery just yet as any signs of rapid growth might be taken as a signal that the Fed will raise rates sooner than expected. The Fed instead wants us to remember that the economy remains in a deep hole and as long as it is in that hole we should expect inflation will remain below target. And inflation below target means no rate hikes.
- The Fed updated its guidance on asset purchases to clearly link it to economic outcomes; we have no reason now to think the Fed will pull back on the asset purchase program until the economy shows substantial further improvement. The November language on asset purchases:
In addition, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.
was updated to:
In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.
The phrase “over the coming months” has a time-based element that felt inconsistent with the outcome-based guidance for interest rates. Now the Fed explicitly intends to hold the size of purchase at or above the current pace until the Fed achieves clear further progress toward its economic objective. Note though that “further progress” is not complete progress. The Fed will pull back on the asset purchase program before raising interest rates. When and under what conditions? Powell declined to answer that question but did promise there would be advance notice. Look for that notice to begin next year if the economy looks to rebound strongly as expected by mid-2021.
- The Fed sharply revised upward its economic expectations but held the rates forecast effectively steady. This is a de facto easing of policy. Consider the updated projections from the Summary of Economic Projections:
Remember, these are not an official forecast but they do provide an indication of which way the forecasting winds are blowing. Those winds are now blowing hard in a positive direction. The Fed now anticipates just 5% and 4.2% unemployment at the end of 2021 and 2022 respectively which, needless to say, would be a dramatically more rapid recovery than the experience of the last expansion. The Fed though does not see this expected improvement as reason to tighten policy.
One way to view this is that a faster than anticipated improvement in outcomes implies that the short-run neutral rate of interest is likely also rising more quickly than expected. Rather than trying to match that with a higher policy rate and holding accommodation neutral, the Fed is holding the policy rate constant thus in effect increasing accommodation.
- The Fed continues to set policy in accordance to its updated strategy. Even though the Fed see unemployment dropping close to its estimate of the longer run rate, 4.1%, at the end of 2022, this improvement has no bearing on the decision to raise or not raise policy rates. The Fed no longer sees closing the estimate unemployment gap as by itself a reason to hike interest rates. The Fed needs to see actual inflation sustained moderately above 2% to justify a rate hike. And with no such inflation expected, no rate hike is forecast.
Bottom Line: Although the Fed did not change the asset purchase program, the new guidance and updated forecasts are together a dovish policy signal.