The Federal Open Market Committee this week will almost certainly provide insight into its monetary policy path by extending the weighted average maturity of its Treasury purchases while simultaneously keeping the policy rate effectively at zero.
We think that the committee will commit to asset purchases for the duration of the pandemic.
The Federal Reserve’s Summary of Economic Projections will certainly include an improved growth and unemployment forecast in 2021 and 2022, without any meaningful increase in inflation and no rate hikes on the horizon.
Moreover, the focus of fiscal policymakers and investors will be squarely on the ”dot plot,” the Fed’s interest rate forecast that currently implies that the policy rate will remain at zero through 2023. Given the arrival of a vaccine and prospects for a period of stronger economic growth in 2021 and 2022, it is very likely that a few of the individual forecasts that comprise the dot plot will imply a rate hike before the end of 2023. But the median forecast that makes up the Summary of Economic Projections will continue to imply zero rates through the end of 2023.
The November FOMC minutes indicated that most participants wanted to provide new guidance fairly soon, meaning the December meeting. Now, the question is: What does this mean?
In our estimation, this guidance will link policy to the evolution of the pandemic and its impact on economic activity. We think that the committee will commit to asset purchases for the duration of the pandemic, which should keep market expectations aligned with policy intentions.
Perhaps more important, given the continuing distress in the labor market, the case is strong for the extension in the maturity of asset purchases to dampen rates at the end of the curve. The economy is facing a difficult period through the first quarter of 2021. Although the economy will move back to full potential by early 2022, it will be the middle of the decade before the economy is anywhere near full employment.
Second, our sense here is that the FOMC is signaling to market participants to prepare for a tapering of asset purchases later in 2021 or the following year. Unfortunately, the committee does not appear ready to link policy to a specific inflation or unemployment threshold, so qualitative guidance appears to be whatever individual market participants want it to be. This tapering will most likely take place when mass vaccinations reach a threshold that imply herd immunity, which of course is a recipe for volatility next year and something on which the Fed will need to provide greater clarification.
The news conference by Fed Chairman Jerome Powell on Wednesday will most likely revolve around the need for the fiscal authority to act to offset the adverse impact of the pandemic and the lingering controversy around the Treasury’s ending of its emergency liquidity programs aimed at the middle market and municipal bond purchases.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
