For a meeting so unlikely to see any major policy changes, the agenda for the Federal Open Market Committee meeting next week is actually quite crowded with substantive issues, and how they will be addressed will shape much of the Fed’s near term policy options.
A few points:
** First, we can only imagine the alternative drafts the staff are preparing for the post-meeting statement on Thursday, but our sense is that among them is a draft sentence reaffirming the FOMC’s commitment to ensure smooth market function. Perhaps Tuesday will go relatively smoothly with a clear presidential winner, but there remain plausible scenarios of extended political and legal uncertainties, and the FOMC will be prepared to move swiftly and firmly with an array of balance sheet measures to calm any systemic-threatening spillover into market dislocations.
** That said, short of a forced move to calm excessive market volatility, we do not expect any change or signals of a change in the Fed’s current $120 billion a month in treasury and MBS asset purchases. The FOMC is instead far more likely to punt the issue to the December meeting, at the earliest; the hope is that by then there will be at least some greater clarity on stalled fiscal policy and the evolution of the Covid pandemic now surging to another peak of infections.
** If truth be told, our sense is that a solid Committee majority are for now skeptical of the cost/benefits to either adding to its $80 billion in treasury purchases or weighting the purchases to longer term treasuries. The transmission of further accommodation into the real economy through the so-called “duration” channel is sorely limited by rates and a term premium that are already so low. Indeed, our sense is that Fed officials will be approaching further balance sheet measures with caution, certainly without a more forceful fiscal policy, in large part due to a heightened sense of the risks to financial stability.
** Financial stability is in fact likely to be a topic of special interest at the meeting. As we have written previously (SGH 10/16/20, “Fed: Where This is Heading”), staff have been assessing the repercussions of the massive intervention to ease the severe market stresses of last March. The November meeting should see an extended discussion of their findings and possible recommendations that will be incorporated into the Board’s Financial Stability Report, and the Basel Supervisory Committee’s Financial Stability Board report to the G20, both due later in November.
** The lack of a more muscular and timely fiscal boost to aggregate demand is also likely to lead to growth and employment downgrades at the meeting, with more somber language in describing the outlook. Last September, many if not most of the FOMC had at least $1 trillion or more in fiscal support penciled in, and while a delay in federal fiscal income and state support should not translate into a sustained lower growth and employment trajectory, the near term uncertainties will elevate downside risks in labor market scarring and lower business spending. Adding to the lowered expectations is Europe’s struggle with the pandemic and renewed national lockdowns.
** It is worth noting, however, there remains a sliver of upside risk to the Fed’s base case outlook. Despite the ebbing momentum, and now the setbacks to a fiscal package and the renewed surge in Covid infections, the economy is nevertheless still in recovery from the devastation of the second quarter, and some FOMC members will argue a burst of repressed spending on the back of a confirmed vaccine rapidly becoming widely available and an eventual fiscal support package could be an upside game changer. In any case, this balance of risks amid so much uncertainty will reinforce the Committee’s desire for maximum policy flexibility going into the turn of the year.
** And finally, that the FOMC’s November meeting next week is pushed back a day to get out of the way of the US presidential elections is in a way telling. While it is doubtful a mention of the election makes its way into the post-meeting statement or even in any length in the meeting Minutes, more so than any other election outcome in memory, who wins the presidency and which party controls the Senate will be hugely consequential in shaping the Fed’s policy options and operational independence for years to come.
** For one, the Board will have to decide, after discussions within the FOMC, whether to extend the 13-3 credit facilities beyond their December 31 end date, perhaps to at least align with the March 31 end date for the Commercial Paper Funding Facility. In the same vein, they may opt to ease the terms of access to the 13-3 credit, as the Board just announced earlier today in lowering the minimum loan size for the Main Street Lending Facility to $100,000.
** If the economy should turn south, and yields remain so low it weakens the transmission of policy easing into the real economy, the direct lending and market support of the 13-3 facilities could become even more of a forceful policy tool going forward. But unlike rates, which are firmly within the domain of the central bank, that is less the case with the balance sheet, and Treasury already has an equal say in the status and fate of the 13-3 facilities.
** And whether the policy and strategy debates begin at length next week or in December, the FOMC will have to come to terms with the complex issues of a potential “fiscal dominance” that will almost certainly come into play as soon as next year. In some sense, there will be a certain “honeymoon” period through at least next year when Fed and Treasury objectives to drive a sustained recovery are aligned, with monetary policy adopting a more or less secondary supportive role to fiscal policy taking the lead, dominant role in driving aggregate demand and even higher inflation expectations.
** Even before any return of inflation that would dramatically alter the political dynamics, that new fiscal/monetary balance will require a degree of consensus and cooperation on debt issuance, central bank balance sheet policies, and financial market regulatory policies not seen since the pre-Accord period when the Fed agreed to cap the entire yield curve in order to finance the costs of the Second World War. There will also be a fair degree of turnover among the Board of Governors in the coming years on top of the two vacancies still unfilled, as well as a normal rotation of new district presidents.
** We doubt any of the last points are frankly going to take up much, if any, of the Committee’s time next week; other issues are a greater and more immediate priority. Chairman Powell will likewise no doubt deftly deflect any press questions on fiscal dominance and refrain for now on too much detail on the Fed’s balance sheet policy options at his post-meeting presser next week.
** But we are pretty certain all of these complex policy and institutional issues will be a major theme of staff and FOMC discussions in the coming months once the elections provide a sense of the likely political and policy priorities of the next Congress and whoever is residing in the White House.