Federal Reserve Chairman Jerome Powell may have put the kibosh on the most recent taper talk with his “no time soon” edict a week or so ago, but the Fed’s balance sheet policy options, including the eventual taper and how to communicate it, will still rank high among the agenda items at this week’s Federal Open Market Committee meeting. It will likewise draw more than its fair share of questions at the post-meeting presser tomorrow afternoon.
** We expect Chairman Powell will in fact shy away from going into too much detail on either the tapering or rates lift-off scenarios, and to instead put his accent not on the eventual exit, but on the long runway of communications in the approach to changes to come on either policy front. There will be a sequence of policy messaging through this very critical year, and in the near term, the emphasis will stay on the Fed’s very dovish reaction function to keep the US economy running as hot as possible for as long as possible.
** Our sense is of a firming consensus across the FOMC that the Fed may not get a second shot at achieving its twin mandates on maximum employment and an average 2% inflation. We take Chairman Powell, as well as Treasury Secretary Janet Yellen, at their word when they vow to avoid the previous policy errors of reducing fiscal support and monetary accommodation too soon. Monetary policy to underpin the lead of an aggressive fiscal policy looks set to be the guiding North Star to the US policy mix deep into this year.
The Alignment of Rates and Balance Sheet Guidance
One reason not to expect much in the way of changes in the statement tomorrow or a new turn in what the Chairman may telegraph in his responses to press questions is that FOMC members are generally pretty pleased with the December meeting’s alignment of the guidance on balance sheet and rates policy: the statement language is vague enough but pointing directionally to the Committee’s intentions that there is something there for everyone to ensure Committee consensus.
Chairman Powell will likewise stick to the script in his presser that, thanks for asking, but it is just too early to speculate on the eventual exit from the current $120 billion a month in treasury and MBS purchases. And on that, the entire FOMC would agree, it is too early to go on about the if and when to taper, there will be plenty of time further down the road – we are thinking sometime in the summer at the earliest — to fine tune the messaging on the path of the balance sheet policy.
That said, however, we would nevertheless note that the willingness expressed by some Committee members to consider a start to tapering this year was not a messaging misfire per se — each was careful to couch their remarks in outcome-based scenarios — but in fact the comments reflected an unease felt by many if not most of the FOMC about piling on to the balance sheet at an annualized $1.44 trillion clip and God knows how much in excess reserves being stuffed onto the balance sheets of the commercial banks — not to mention what all that high powered money may portend for financial asset valuations and market stability.
But while those hard to hide anxieties are fuel to the market and media attention on when the Fed will taper down its asset purchases, we would still caution that the list of the FOMC’s balance sheet policy options will in fact be more varied than just that by the time a decision is being weighed.
Even with a strongly rebounding economy, for instance, there could still be a delay to a tapering or even more, not less, accommodation through a Twist-like operation or a shift to a weighted average maturity to long term purchases which, as we wrote previously (SGH 12/16/20, “Fed: The Hippocratic Meeting”), could be coupled to a one-off reduction in the monthly asset purchases before a subsequent tapering.
It will just depend on the growth outlook, if and why real yields are rising and how financial conditions are evolving relative to the forecast, and crucially, on the momentum to the hoped for rise in inflation and inflation expectations and, indeed, where the votes are on the Committee.
The Outlook and a Policy Flexibility Premium
The statement tomorrow will update the FOMC’s read on how dreadful the near term jobs and economic activity is likely to be as the pandemic continues to take its toll even if it has hopefully peaked in its damage done. But equally, we should also get a clearer confirmation of the Fed’s confidence in how robust the rebound in growth is likely to be in the second half of the year. We think a cautionary downside risk of an uneven mass vaccination – still the main driver to the outlook — will temper the embrace of a more aggressive upgrade to the outlook.
There will nevertheless be enough aggregate demand driving spending later this year to warrant prudent reassurances, a careful watch will be kept for any evidence of a sustained rise in measured inflation and inflation expectations, and there will be vows for an equal close monitoring for signs of financial dislocation or excesses. But the broader base case remains for a very slow moving rise in inflation that is far from the sort of accelerating overshoot of the 2% mark that would draw a policy response.
That reminds us that we think Chairman Powell is likely to be asked for clarification on Vice Chairman Richard Clarida’s recent remarks when he seemed to add a “for a year” threshold to his definition of a “temporary price-level targeting” on how long inflation would have to run above 2% before rates would be lifted off the effective lower bound.
We are skeptical a consensus of the FOMC, or any future FOMC, on rate policy will hold together with inflation running above 2% for that long. The decision on a lift-off in rates again we suspect will instead be premised on why and with what momentum measured inflation and inflation expectations are moving higher into a sustained overshoot. The accent is on policy flexibility, in other words.
The SLR and Warehousing
There are two other issues that may come up for discussion in the January meeting and make their way into public remarks and the subsequent Minutes that we thought worth highlighting.
The first is that the wider FOMC may discuss the coming Board’s decision on whether to extend the exemption to the Supplemental Leverage Ratio that expires March 31. On balance, we would assume the Board will find a way to extend the exemption, mostly to ensure the big banks have the regulatory room and balance sheet capacity to absorb the coming flood of excess reserves the Fed is likely to send their way in the coming months.
We are frankly unsure, however, of how deep the Board support was for the original exemption first extended at the height of the market stresses last March, or for that matter, what the new Treasury and other Biden Administration officials or the Democratic-controlled jurisdictional Senate as well as House Committee chairs think about the need for regulatory capital relief for the big banks. But we may see evidence of which way the decision is heading if Chairman Powell is asked on the issue in the presser or in the mid-February release of the meeting Minutes, if not before.
The other issue is more of an aside than anything else, but a good chunk of the FOMC’s January meeting discussions comprise the housekeeping votes to approve various appointments or authorize the instructions to the Open Market Desk and the swap or other arrangements with foreign central banks.
Each January also lays down the protocols for “warehousing.” Normally, this has to do with coordinated foreign exchange interventions with Treasury, in which the Fed would agree to swap non-dollar holdings from Treasury’s Exchange Stabilization Fund as well as perhaps drawing on its own balance sheet to bolster Treasury’s intervention firepower.
In the current circumstances, it is not so much an FX intervention that may draw on the warehousing call, but if Treasury, in consultation with the Board of Governors, should seek to relaunch 13-3 emergency lending. Treasury Secretary Yellen was clearly cool on the likely need to do so in her confirmation hearings, as we expected she would be (see SGH 12/1/20, “Fed: The Yellen-Powell Nexus”).
But if for whatever reason it seems prudent to avoid turning to Congress for funding, the capital and credit backstops to the 13-3 Special Purpose Vehicles managed by the Fed could be provided out of the ESF funding. And to access the full $75 billion or so in the ESF, Treasury would need to turn to the Fed to swap its non-dollar holdings.
We have no sense this is a policy step under active consideration, but any tweaks or refinements in the authorizations on the warehousing issue, if thought to be needed, might offer some clues to any coming collaboration between Treasury and the Fed going forward.