By Steven K. Beckner
(MaceNews) – For the Federal Reserve these days, it’s all about shaping and managing expectations – expectations for indefinite continuation of ultra-accommodative monetary policy. That effort will continue at the Fed’s Dec. 15-16 Federal Open Market Committee meeting.
The FOMC heads toward its final meeting of 2020 amid very unusual circumstances – continued uncertainty about recovery from Covid-induced recession, a disputed election and, despite all that, buoyant financial markets fueled by the easiest monetary policy in U.S. history, not to mention unprecedented federal deficit spending.
Of course, the FOMC has already gone to great lengths to preempt any and all economic and financial problems. So expect Chairman Jerome Powell and his fellow policy-makers to double down. The only likely shift is a change in its “forward guidance” to incorporate asset purchases into its new outcome-based policy framework.
FOMC participants will be revising their quarterly economic and interest rate projections, and if anything the Summary of Economic Projections (SEP) seems likely to contain somewhat more upbeat forecasts than contained in the September SEP, especially given the promise of vaccines to counter the coronavirus. But uncertainty remains extraordinarily high, as officials keep reminding us.
This doesn’t mean rate projections will change much. In the last SEP, published on September 16th, FOMC participants anticipated the federal funds rate would stay near zero through 2023, and there have been no signs of much change of that sentiment. The FOMC essentially reaffirmed that intention after its Nov. 4-5 meeting.
Fed officials have sounded surprisingly optimistic lately. Although fourth quarter GDP growth will be down considerably from the third quarter record of 33.1%, it is no longer expected to be negative. The Atlanta Fed is forecasting 11.2% annualized fourth quarter growth.
Job growth slowed in November, as non-farm payrolls grew a less-than-expected 245,000, the smallest gain in seven months. But that’s not terribly surprising as state and local governments continue to shut down businesses. Despite that damper on the labor market, the unemployment rate dipped further to 6.7% (compared to 14.7% in April), with the help of lower labor force participation. Average hourly earnings picked up to 4.4% from a year ago.
The Institute for Supply Management’s surveys found expansion in both manufacturing and non-manufacturing industries last month, just not quite as much. The beige book compiled for the upcoming FOMC meeting found that four of 12 Fed districts had “little or no growth.”
But the housing sector is booming, and consumer spending has held up so far, despite reduced incomes. Powell called it “strong” in Dec. 1 testimony before the Senate Banking Committee.
Although they are allowing for a potential first quarter dip, many officials project growth well above trend next year, depending on the extent to which an effective vaccine gains wide distribution.
Powell even spoke of “upside risk” as the vaccine comes on stream and governments presumably ease restrictions on commerce.
Philadelphia Federal Reserve Bank President Patrick Harker expects growth “to pick up in the second half of 2021 and through 2022 before a light tapering in 2023,” provided a vaccine becomes available sometime in the spring or summer of next year and an additional $1 trillion of fiscal support is forthcoming. Both conditions look increasingly likely.
Despite this hopeful tone, Fed officials have been unrelenting in their commitment to keeping short-term interest rates very low as far as the eye can see and to keeping downward pressure on already historically low long-term rates.
In November, the FOMC voted unanimously to keep the federal funds rate in a zero to 25 basis point target range and anticipated “it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” The FOMC also agreed to maintain asset purchases at “the current pace” of $120 billion per month.
That basic message is not likely to change at the upcoming meeting or, for that matter, any time in the foreseeable future, even if the economy surprises on the upside. Since the early November meetings, policy-makers have expressed considerable satisfaction with their current monetary settings and with financial markets’ reception of those policies.
Powell, famously, has said the Fed is “not even thinking about thinking about raising interest rates,” and that widely shared view applies to both ends of the yield curve.
Although the 10-year Treasury note yield has crept up recently, it remains below 100 basis points, leaving the Fed comfortable that asset purchases are serving their intended function – “to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”
Inflation remains the least of the Fed’s concerns. Faster price increases for some goods have been offset by soft service prices, leaving policy-makers complacent. The FOMC is sure to continue actively courting an overshoot of its 2% inflation target “for some time,” even past the achievement of full employment.
Certainly we’re not getting signals of impending policy changes from Powell.
As he told the Senate Banking Committee, the Fed “will continue to provide very strong support to the economy through our tools” and added, “we remain committed to fully use our tools for as long as necessary.”
In an obvious reference to the FOMC’s pledge to leave the funds rate near zero until it reaches full employment and average 2% inflation, Powell vowed, the Fed “will keep at it until we’re really done.”
He added that the Fed “is not going to preemptively raise rates” even if unemployment falls below the estimated “natural rate” unless there are signs of greater inflation pressure than the Fed expects and wants.
At the same time, Powell gave fiscal policy “the lion’s share” of credit for the “faster than expected” recovery that has occurred so far and told senators “it may be we need more on that front .…”
Although no change in current monetary policy is likely, it is probable the FOMC will further amend its “forward guidance” – that is, extend its forward guidance to asset purchases along the lines that it applied to the federal funds rate target in September in keeping with the August restatement of its long-run monetary policy strategy or “framework.”
Fed officials have so hinted for the last few months, and the minutes of the Nov. 4-5 FOMC meeting dropped another heavy hint: “Many participants judged that the Committee might want to enhance its guidance for asset purchases fairly soon. Most participants favored moving to qualitative outcome-based guidance for asset purchases that links the horizon over which the Committee anticipates it would be conducting asset purchases to economic conditions.”
Only “a few participants,” according to the minutes, “were hesitant to make changes in the near term to the guidance for asset purchases and pointed to considerable uncertainty about the economic outlook and the appropriate use of balance sheet policies given that uncertainty.”
In other words, if the majority has its way, the FOMC would condition the continuation and perhaps, at some point, expansion of purchases of Treasury and agency mortgage backed securities, on progress toward achievement of the Fed’s “dual mandate” as now understood – namely achieving “maximum employment” and “price stability,” i.e. 2% average inflation.
As now defined, price stability involves “flexible average inflation targeting.” As the FOMC put it at its last meeting, “With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”
Maximum employment also has a new meaning these days. In its Aug. 26 Statement on Longer-Run Goals and Monetary Policy Strategy, the FOMC “emphasized that maximum employment is a broad-based and inclusive goal and reports that its policy decision will be informed by its “assessments of the shortfalls of employment from its maximum level.” The original document referred to “deviations from its maximum level.”
Fed officials have let it be known they are looking not just at headline unemployment rates, but at other indicators, such as labor force participation. And they will no longer be bound by Phillips Curve notions, which in the past have inclined the FOMC to raise rates whenever the labor markets reached putative full employment, even when wage-price pressures were muted.
Fed Vice Chairman Richard Clarida elaborated on the FOMC’s new forward guidance a few weeks ago: “Along with other complementary conditions, inflation must have risen to 2% before we expect to lift off from the ELB (effective lower bound). This condition refers to inflation on an average basis.”
Clarida, Powell’s top monetary advisor, said the FOMC chose “a one-year memory for the inflation threshold” – that is one year of 2% average inflation – “that must be met before liftoff is considered.” But he noted the FOMC has also said it won’t raise the funds rate until inflation is “on track to moderately exceed 2% for some time.”
That language leaves room for interpretation. “What ‘moderately’ and ‘for some time’ mean will depend on the initial conditions at liftoff…,” said Clarida. “Crucially, the Committee’s judgment on the projected duration and magnitude of the deviation from the 2% inflation goal will, at the time of liftoff and every three months thereafter, be communicated” in the SEP. The SEP has served as a communication tool in the past.
The FOMC’s policy statement can also be used as “a platform to communicate the Committee’s tolerance for deviations of inflation from the 2% longer-run goal….”
Aside from the inflation rate, the FOMC will be “making sure that inflation expectations remain anchored at our 2% objective,” Clarida said, adding he will “closely follow the Fed staff’s index of common inflation expectations (CIE).
Even after liftoff, the FOMC may well keep policy very accommodative for a good while if inflation and inflation expectations continue in a pattern the Fed deems unacceptable.
“Other things being equal,” said Clarida, “if at the time of liftoff the CIE index is below its pre-ELB level, then my desired pace of policy normalization post-liftoff to return inflation to 2%—as well as the projected pace of return to 2% inflation—would be somewhat slower than if the CIE index at the time of liftoff is equal to its pre-ELB level.”
The average rate of PCE inflation since the new framework was adopted in August 2020 is another consideration. “If average inflation since August 2020 turns out to be notably below 2%, then my desired pace of policy normalization post-liftoff—and the implied pace of return to 2 percent inflation—would, other things being equal, be somewhat slower than if average inflation since adoption was close to or equal to 2 percent,” he said.
Watch the SEP. “Once the conditions to commence policy normalization have been met, the SEP ‘dot plot’ will convey the median participant’s projections over a three-year horizon not only for inflation, but also for the pace of liftoff as well as the ultimate destination for the policy rate,” Clarida advised.
It seems highly likely the FOMC will announce on Wednesday, Dec. 16 the same sort of forward guidance will now be applied to future asset purchases.
The Fed seems less likely to alter the size or composition of asset purchases in the near-term, but that is a strong possibility in coming months. What form that will take is uncertain and will obviously depend on a host of factors.
Officials have let it be known that, while they think the current asset purchase program is appropriate, they are ready and able to make adjustments. Should the economy prove weaker than expected, they would readily augment the size of purchases.
There is a consensus on holding down yields to bolster housing and other interest-sensitive sectors as long as needed. Were the 10-year yield to pop above 1%, increased bond buying would be on the table.
Powell and his colleagues are keen to persuade everyone the Fed is not “out of ammunition,” although their lobbying for additional fiscal support belies that.
At the least, expect a full discussion of asset purchases – their size, composition and communication – at the upcoming meeting.
Powell and others have repeatedly pledged to use “all our available tools” to fulfill their dual mandate. In that regard, Clarida hinted at a readiness to tweak asset purchases: “Looking ahead, we will continue to monitor developments and assess how our ongoing asset purchases can best support achieving our maximum employment and price stability objectives.”
Per the November FOMC minutes, the December SEP will be released under new guidelines. Participants unanimously supported “accelerating the release of the full set of SEP exhibits from three weeks after the corresponding FOMC meeting, when the minutes of that meeting are released, to the day of the policy decision and adding new charts that display a time series of diffusion indexes for participants’ judgments of uncertainty and risks.”
Fed officials are exceedingly confident about the efficacy of signaling their intentions for future rate and/or QE action (more than some observers might credit.)
Cleveland Fed researchers recently found “forward guidance was effective in altering the public’s expectations about future policy rates if it was accompanied by a Summary of Economic Projections but not expectations about economic fundamentals. The publication of the SEP allowed the public to get more quantitative information about the likely path of future monetary policy in addition to the qualitative information given in the post-meeting statements.”
On another front, the fate of the Fed’s Section 13-3 special lending facilities is in doubt, at least for a while.
Treasury Secretary Steven Mnuchin, citing provisions of the CARES Act, opted not to extend five of those facilities (the Municipal Liquidity Facility, the Main Street Lending Program, the Secondary Market Corporate Credit Facility, the Primary Market Corporate Credit Facility and the Term Asset-Backed Securities Loan Facility) for which Treasury has provided capital. He asked the Fed to return to Treasury $430 billion in unused funds.
But the Fed can ask Treasury to resume providing capital to backstop those facilities if it deems them necessary to address financial market strains or credit needs. With Mnuchin prospectively to be replaced by former Fed Chair Janet Yellen, the Fed would probably have no difficulty reviving those programs — perhaps much more if it wishes.
Yellen worked closely with Powell when she chaired the Fed from 2014-18, and there is every reason to think they would have a good relationship if Yellen does become Treasury secretary.
If anything, some fear the Fed could become too cozy with the Treasury and provide the kind of underwriting of debt funding that the Fed forswore after the postwar Fed-Treasury Accord expired. (Arguably, it is already doing so with massive purchases of Treasury securities, which have greatly lowered the cost of financing record deficits).
As Treasury secretary, Yellen would spearhead a Biden administration’s economic policy and its relationship with the Fed. A dyed-in-the-wool Keynesian, her leadership raises the prospect of a monetary-fiscal interaction the likes of which we’ve seldom seen.
Although Yellen initiated funds rate “normalization” in December 2015, liftoff came belatedly – seven years after it was slashed to near zero during the Financial Crisis. Yellen repeatedly cited the need to spur aggregate demand during her Fed tenure. She is likely to be even more assertive in the current climate.
It’s doubtful she’ll meet much resistance from Powell, who told senators “the risk of overdoing it (on spending) is less than the risk of under-doing it.” Ten years ago, the Fed had an extensive discussion of the “fiscal limit” at its Jackson Hole symposium, but such concerns seem to be far from Fed minds these days.
For better or worse, the Treasury and the Fed will likely concur on “fiscal stimulus,” with the latter willingly helping to finance the resultant budget deficits at as low a cost as possible.
Then there’s dollar policy.
As chair and before that vice chair of the Fed, Yellen played an active role in discussions with Group of Seven and Group of 20 finance ministers and central bankers. As Treasury secretary she would take the lead role.
Even though monetary policy ultimately determines the dollar’s purchasing power and exchange rate, the Fed chairman defers to the Treasury secretary as chief dollar spokesman.
Reflecting President Trump’s preference for a more competitive exchange rate, Mnuchin has not advocated a strong dollar. Yellen seems likely to be even more inclined to accept dollar depreciation. The foreign exchange markets may be happy to oblige, judging by recent trends.
Yellen is also apt to be more inclined to back more financial regulation. And she could lend aid to a more general reversal of Trumpian deregulation, which has helped spur more rapid growth. A heavier regulatory hand and higher taxes could complicate the Fed’s job by slowing productivity growth, raising energy costs and discouraging investment.
Joe Biden, assuming he is inaugurated president in January, could put his mark on the Board of Governors over time. The U.S. Senate confirmed St. Louis research director Christopher Waller, but there seem to be insufficient votes to confirm Trump’s other nominee, economist Judy Shelton. That leaves Biden with just one vacancy to fill, but that could change.
The ultimate prize, of course, is the Fed chairmanship. Powell’s term expires in February 2022. The pliable lawyer, 67, could be reappointed, though that’s not certain.
It’s hard to see how much difference new faces would make, given that monetary policy is already easier than it’s ever been and given the FOMC’s expressed intention to keep rates low “for a long time,” as St. Louis Fed President James Bullard recently said.
But, as time goes on and the economy hopefully moves back to full employment, an altered composition of the FOMC could have significant influence on the timing of “liftoff” and QE tapering.
One suspects monetary “normalization” will come even later than it might have otherwise.