The Federal Open Market Committee made no material changes to the path of monetary policy on Wednesday as it held the policy rate between zero and 25 basis points and maintained its forward-looking guidance on interest rates and asset purchases.
The Fed in its statement included language that did not point to an exit or end point on its accommodative policies, so we think that the Fed is prepared to engage in an open-ended period of policy innovation to support the years it is going to take for the economy to dig out of the hole caused by the pandemic.
We think the Federal Reserve will implement the little-used policy of yield curve control in 2021.
We point to this specific language to support our view: “The ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
Given the damage to the economy caused by the pandemic, we expect that programs like the soon-to-be-launched Main Street Lending Program will persist for years, much like some Depression-era Fed and Treasury programs.
Fed Chairman Jerome Powell indicated that the Fed would soon issue a new term sheet for the Main Street Lending Program. We would anticipate more attractive financing terms which will stimulate demand for what is likely to be another oversubscribed lending facility.
Powell also indicated that there will be an update that will sound like different loan products within the facility.
In our estimation, the Fed is caught in the interstitial between its current rate, forward guidance policies and what we think will be a policy of yield curve control that will need to be put in place in 2021. Yield curve control targets long-term interest rates at a specific level that is then achieved by a central bank buying or selling as many bonds as necessary.
It is quite clear that right now the Fed’s asset purchases have been geared toward the successful reconstitution of market functioning, and that over time the central bank will move back toward a range and pace of purchases for purely monetary policy reasons.
The central bank has purchased $1.5 trillion in Treasuries and approximately $500 billion worth of agency mortgage-backed securities to restore functioning in Treasury and mortgage markets.
While the Fed’s preferences may be skewed toward large-scale asset purchases and forward guidance, the reality on the ground — given the aid needed in the real economy and the stimulus that will be required to obtain escape velocity in coming years and address the need to account for significantly higher Treasury issuance — is that the Fed will need to engage in yield curve control.
However, despite the reluctance of some policymakers at the Fed, it is difficult to foresee how the inevitable integration of Treasury and Fed policy will not move toward yield curve control to complement the issuance of U.S. government debt to support the economy amid record levels of debt to GDP and annual operating deficits.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.