Coronavirus is responsible for many "firsts." Apart from the obvious impact on daily life there are firsts for the economy and monetary policy as well. Since March, all of the significant policy changes from the Fed have been unscheduled and there have been zero significant policy changes on scheduled Fed announcement days. That's a record, and it raises a question about what we'll see today in light of the most recent unscheduled policy change at the end of August.
The late August framework update is a bit different than the other emergency policy changes. It wasn't responsible for a drastic rate cut, a huge glut of bond buying, or a slew of emergency lending programs. Rather, it's more like the Fed's way of updating its playbook to implement what it has learned from previous games. Given the proximity to today's meeting, one cannot help but wonder--if not assume outright--that the playbook was updated with the intent of running one of the new plays today.
I've fallen more in the camp of "assuming outright." In other words, the framework update 2.5 weeks ago seemed too precipitous to be incidental. I can't imagine why they felt the need to unveil it 2.5 weeks ago unless it was to pave the way for "something else" today.
When we start imagining what "something else" might look like, there are only so many options--many of them laid out in previous Fed speeches. The most informative speech came 2 weeks ago from Vice Chair Clarida. here are some highlights:
- NEW FRAMEWORK NOT A JUDGEMENT THAT PREVIOUS STRATEGY WE INEFFECTIVE, BUT THAT LOW UNDERLYING INTEREST RATES, OTHER CHANGES TO ECONOMY REQUIRED NEW APPROACH
- FED'S CLARIDA SAYS LIKELY THAT DISCUSSION OF OTHER TOOLS WILL NOW RESUME WITH CONCLUSION OF FRAMEWORK REVIEW
- ASKED ABOUT YIELD CURVE CONTROL, FED'S CLARIDA SAYS IT IS IN THE TOOL KIT BUT NOT SOMETHING WE'RE ABOUT TO DEPLOY
- CLARIDA SAYS THRESHOLD BASED GUIDANCE IS IN THE TOOL KIT AND POTENTIALLY HAS A ROLE
- CLARIDA REPEATS NEGATIVE RATES NOT SEEN AS ATTRACTIVE POLICY FOR U.S.
- CLARIDA: FORWARD GUIDANCE AND LARGE SCALE ASSET PURCHASES “HAVE BEEN AND CONTINUE TO BE” EFFECTIVE WAYS TO SUPPORT THE ECONOMY
This is a treasure trove for those looking for a preview of today's announcement. Here's what we know is off the table:
- Negative rates
- Yield curve control
Here's what we know is potentially on the table:
- Threshold based guidance (i.e. specifically targeting 2.25-2.5% inflation for a time or more clearly defining a symmetrical 2% inflation target)
Here's what is almost certainly on the table:
- A change in forward guidance (i.e. what the Fed says it will likely be doing based on the state of inflation and the labor market).
- Some small-to-big change on bond buying programs (large scale asset purchases).
On the small end of bond buying changes, the Fed could simply change the way they refer to them by dropping the verbiage about liquidity and introducing verbiage about accommodation. In other words, they would stop saying they're buying bonds because the economy and markets NEED it and instead say bond buying is designed to provide accommodation and help the Fed achieve its inflationary goals.
On large end of the spectrum, they could actually announce quantitative changes to the program (bigger bond buying amounts) or a calendar-based guarantee, likely with the verbiage "at least." For example, "large scale asset purchases will continue at least through June 2021."
In the middle ground would be an update to the composition of the Fed's bond buying portfolio--one that allows them to purchase more long-term debt at the expense of short term debt. The thought is that buying longer-term debt is technically more accommodative. The easiest way to think about this is from a consumer point of view where a 30yr loan is easier to make payments on than a 15yr loan.
In addition to these changes, we also have to consider the Fed was just being "weird" in late August and doesn't actually have any big bombs to drop today. In fact, the contrary opinion would be that the Fed knows its dot plot (economic projections) is going to show something that needs to be explained. For instance, as I alluded to in yesterday's Huddle video, the Fed may see it's framework change resulting in stronger economic forecasts versus the last forecasts in June. Perhaps they wanted to update the framework so that markets wouldn't "freak out" and assume the Fed was much closer to removing accommodation than it actually is.
This last scenario is what we DON'T want to see today from a short-term bond volatility standpoint. Enough of the market believes the Fed will be doing something accommodative that it would come as a fairly big shock if turns out the Fed was merely gearing up to defuse concerns about stronger economic projections.
The Fed announcement comes out at 2pm along with the economic projections. Powell's virtual press conference follows 30 minutes later. Mortgage lenders are always quicker to reprice on Fed day with some of them simply closing the lock desk at 2pm while they wait to see where the chips fall.
Either way, it's ALWAYS good to remember that market participants have exhaustively considered all of the possibilities we can discuss (and more). The market is always positioned for its best guess at the Fed's likely actions, and thus is ready to move either direction of those actions are more or less friendly than expected.