Fed preview: New faces, same old problems
The Federal Open Market Committee (FOMC) convenes today for its first meeting of 2021, with some new faces (not least Janet Yellen at Treasury) but the same old problems facing the Federal Reserve as it seeks to steer the US economy out of the pandemic. The statement is released tomorrow at 19:00 (GMT), followed by the press conference with Chair Jay Powell at 19:30.
Not a lot has materially changed since the December meeting, when the Fed provided updated forecasts on the economic trajectory. Vaccines and stimulus support a bullish case for recovery longer term (eventually things will pan out) but near-term risks to the outlook are elevated (vaccines could be slower to reach people, governments may be reluctant to ease restrictions as quickly as we’d hoped back in November + scarring). The one major change, of course, is the arrival of Biden in the White House. We also have some greater clarity around the stimulus package being discussed and around vaccines (albeit not all positive).
Whilst the longer-term outlook remains solid enough and perhaps a little firmer given greater clarity around the fiscal side of things and vaccines, near term softness presents risks and calls for the Fed to remain very dovish and hammer home its willingness to remain as accommodative as necessary for as long as required. Recent deterioration in the labour market supports the thesis that the Fed will be disinclined to even signal it is thinking about taking its foot off the pedal. Moreover, whilst there is hope the stimulus-vaccine cavalry are riding to the rescue later this year, there is no immediate boost from these and, if anything, it could take longer to benefit from these than first expected during the rotation trade of Nov-Dec. Whilst the holiday (Thanksgiving + Christmas) rise in cases is easing, clearly there is just not enough visibility yet about the pandemic for the Fed to sound anything other than cautious about the near-term outlook. The Fed will be mindful about scarring to the economy long term, but this only cements the case for greater accommodation today.
Nonfarm employment growth is stalling
Financial conditions remain loose and present little by way of a problem for the Fed right now. The recent rise at the long end of the yield curve seems to be down to expected reflationary trends in 2021 and beyond, so is not a major worry. In the last day the yield on 10s has retreated to a three-week low, giving the Fed even less to think about. AIT implies an acceptance of higher inflation anyway, so I’d expect the Fed to remain very relaxed even if/when CPI and PCE prints push up in the coming months.
Financial conditions stay loose
Breakevens outpacing nominal yields
The Fed does not want a taper tantrum, but there has been chatter around tapering of asset purchases that chair Powell among others has been quick to clamp down on. I’d expect he will seek to ram home the message that the Fed is not even thinking about thinking about tapering.
By way of context, two weeks ago some policymakers were talking up tapering of bond purchases by the end of the year, no doubt in part thanks to expected loosening in fiscal policy with the arrival of Biden and co. Officials suggested that mass vaccinations and expansionary fiscal policy could see the FOMC start to discuss reducing its $120bn-a-month asset purchase programme later this year. Even if interest rates are anchored at the front end, any sense that the Fed will pull away the punch bowl is apt to create a headwind for markets.
Federal Reserve Governor Lael Brainard tried to dial down the chatter about tapering, saying the current pace of bond buying would be needed for some time. “The economy is far away from our goals in terms of both employment and inflation, and even under an optimistic outlook, it will take time to achieve substantial further progress,” she said. “Given my baseline outlook, I expect that the current pace of purchases will remain appropriate for quite some time.”
So, we had some open disagreement as policymakers expressed differing views of when a taper might be discussed – Evans, Bostic and Kaplan signalled they could be open to tapering this year, while Clarida, Mester and Barkin did not seem keen. Bullard said the Fed is ‘not close to tapering’ and Brainard clearly seemed uneasy about discussing this just yet.
The man in the hot seat was clear. On interest rates, Powell said: “When the time comes to raise interest rates, we’ll certainly do that, and that time, by the way, is no time soon.” On tapering, he said that “now is not the time to be talking about exit”. Powell stressed that the new average inflation targeting and outcome-led policy embodies a different approach to employment – the Fed won’t be raising rates even if unemployment levels fall to levels that previously would have been considered a warning signal about prices.
The important thing was to get this discussion out in the open early, so the Fed has the foundations to act once inflation does feed through and the pro-cyclical fiscal expansion meets vaccines to generate a strong economic rebound later in 2021. But the time to talk about tapering is not today, and Powell will want to reinforce that message.
The meeting comes just as ex-Fed chair Janet Yellen is confirmed as Treasury Secretary. Clearly the market is of the view that the Biden administration will bring looser, more expansionary fiscal policy, albeit there are concerns about whether the $1.9tn stimulus package will pass muster. Nevertheless, with Yellen at Treasury I see scope for a more cohesive fiscal-monetary structural dynamic at work. Whilst full-scale official embracement of Modern Monetary Theory is some way off, the tacit acceptance of the approach is taking shape. It will be interesting to see if Powell faces any questions about Yellen’s role or MMT.
The rotation of voting members sees some new faces: out go Mester (hawk), Kashkari (dove), Kaplan (neutral) and Harker (neutral). In come Evans (dovish), Daly (neutral), Bostic (dove), and Barkin (neutral).