Market Outlook

The Fed: Support Beyond the Pandemic

By John Bellows, Ph.D., Portfolio Manager, Research Analyst
30 April 2020

The Fed is far from done with its response to the immediate concerns confronting the economy.

The Federal Reserve (Fed) did not announce any significant change to its policies at today’s Federal Open Market Committee (FOMC) meeting. After re-iterating the Fed’s commitment “to using its full range of tools to support the US economy in this challenging time,” the post-meeting statement reviewed the current state of economic activity with a series of alarming observations that included: “surge in job losses,” “significantly lower oil prices,” “impaired the flow of credit” to name a few.

If anything, the Fed’s observations understate the severity of the economic emergency. Indeed, the statement itself hinted at broader set of consequences by saying that the situation “poses considerable risks to the economic outlook over the medium term.” The reference to the “medium term” is important, especially as the Fed’s prior statement in March had referred to only “near term” risks. By looking out to the “medium term” the Fed is setting up policy to be active and accommodative for an extended period of time, and almost certainly well past the resolution of the coronavirus/COVID-19 pandemic.

While there were no new policy announcements, the Fed is far from done with its response to the immediate concerns. Over the last six weeks the Fed has announced a tremendous amount of new policies, and its current task is to implement those policies quickly and to maximum effect. Chair Powell’s comments on that dimension today were encouraging in two respects.

First, Powell reiterated the Fed’s commitment to make these facilities count. After a careful description of what the Fed can and cannot do (Powell specifically mentioned that grants to individuals fall in the latter category), Powell said that “We can do what we can do, and we will do it to the absolute limit of those powers. We will keep at it.” Obviously the facilities that already have been announced are things the Fed can do—after all, the Fed lawyers have already approved those actions—so the straight-forward implication of Powell’s statement is that these facilities will be used aggressively.

Second, Powell made a specific reference to the Corporate Credit Facility and said that it is “near being finalized” and will be running “fairly soon.” Powell also observed that credit markets have stabilized since the Fed’s announcement of these facilities, and he took some credit for the “announcement effect.” The stabilization has meant that over the past month companies have been able to finance themselves and raise liquidity from private investors. This is obviously a good thing, not only for the companies and their investors but also from the Fed’s perspective. Rather than sounding complacent about the stabilization, however, Powell went on to say that, “Of course we have to follow it through. And we will follow through to validate that announcement effect.” For investors still waiting on the Fed to start the corporate purchase program, this comment was as close as could be hoped for in terms of assurance that the commitment remains and the purchases are coming.

Looking forward, there are two areas where we expect the Fed to do more in coming meetings. The first is with regard to its guidance on interest rates. In today’s statement the Fed said, “The Committee 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.” As mentioned above, if the current contraction in economic activity does indeed have medium-term consequences, then it’s likely that the Fed will keep rates close to zero well past the point of the economy having “weathered recent events” and well into the recovery. We expect that it will make such a commitment explicit in coming meetings.

The second is with regard to asset purchases. The Fed’s current posture is to buy US Treasuries and agency MBS “as needed” to support market functioning and financial conditions. At some point that posture is likely to evolve into a commitment to putting downward pressure on yields, in order to both support financial conditions and also to facilitate a continued fiscal response. The Fed has a number of options when it comes time for that, including yield-curve caps and fixed-dollar quantitative easing. While Powell made it clear that it was too early to disclose any specifics, he certainly didn’t do anything to dissuade us from thinking that an announcement in that space is coming at a future meeting.

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Definitions:

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve system.

The Federal Reserve established the Primary Market Corporate Credit Facility (PMCCF) on March 23, 2020, to support credit to employers through bond and loan issuances.

Agency mortgage-backed securities (MBS) are asset-backed securities secured by a mortgage or collection of mortgages issued by federal agencies like Fannie Mae, Freddie Mac and Ginnie Mae.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Capping rates out the yield curve”, or setting yield curve caps, refers to a hypothetical policy by the Federal Reserve of setting maximum levels of yield at a variety of maturities of Treasury securities.

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