The Fed may see better long-term prospects if it releases its economic forecast on Wednesday based on vaccine developments, but it also has the opportunity to disappoint at least some investors who expect immediate changes to their bond purchase program.
The market was divided on whether the Fed would extend the maturity of its $ 80 billion Treasury bond purchases, meaning that long-end purchases like the 10-year bond and 30-year bond would be increased. In theory, this should help keep down the longer-term interest rates that affect mortgages and other loans.
Instead, some economists are expecting the Fed to simply give out more information and guidance on what would cause it to make changes, so that the actual policy change can be kept for later. For now, interest rates are still low, financial conditions favorable, and it is still unclear how much stimulus Congress will give to business.
The Fed will release its statement at 2:00 p.m. and Fed Chairman Jerome Powell will hold a 2:30 p.m. ET briefing.
Given the divided views, the Fed’s statement on Wednesday has the potential to move the markets. To some extent, the bond market has relied on increased purchases of longer-term debt securities and bonds.
“Someone will be disappointed,” said Ian Lyngen, head of US rate strategy at BMO. “I think it’s going to be a tradable event one way or another.” But if it doesn’t change the bond program, he doesn’t expect a big move in the bond market as the Fed continues to uphold the prospect by saying it is ready to act.
“They’ll be reluctant at the end of the day,” said Rick Rieder, chief investment officer, global fixed income for BlackRock. “The question is, will you be reluctant or super reluctant. So expand that [duration of purchases]? I don’t think it matters when you do it, this or the next meeting. I think they will. “
Rieder believes the Fed will eventually change the composition of the assets, but will also increase the treasury it purchases to $ 100 billion and reduce the $ 40 billion in mortgage it is also currently buying.
“I think they are very receptive to buying more assets,” said Rieder. “I think they’ll discuss it instead of doing it.”
Rieder said he expects a stimulus package for the first quarter, although Congress continues to try to find a compromise package this week. Any stimulus will result in much more Treasury debt being issued, and the Fed is watching how big the package will be.
“I think we are entering a new era with more fiscal stimulus, more borrowing and more Fed involvement,” he said.
The Fed’s current bond purchase program is the pandemic-crisis version of quantitative easing that the Fed first introduced during the financial crisis. The Fed rushed to reintroduce the program without the perimeters previously used. This had a strong impact on markets, underscored by the sudden shutdown of the economy last March.
Now the market is expecting a more precise definition of how the Fed will use the program. Some Fed watchers say the Fed would be better off waiting to see what kind of stimulus plan Congress develops before acting, and others, like Goldman Sachs, argue that the record-breaking virus spread is a catalyst for the movement the Fed should be.
“We believe the Fed is slightly more likely to extend the weighted average maturity of its government bonds, although that is a tight call,” they wrote. Goldman economists expect the Fed to get more for its money by buying longer-term Treasuries rather than the shorter maturities that are more influenced by its rate policy.
“We expect the FOMC to adopt results-based projections indicating that buying will continue” until the labor market is on track for maximum employment and inflation is on track to Achieving 2 percent, “a softer version of the thresholds used to start the money rate.” The Goldman economists added.
Citigroup economists see only a 25% chance the Fed will change the bond purchase program, while economists at Bank of America expect the Fed to simply change the language of its program but withhold action. “The focus of the upcoming meeting will be on language changes as we expect the FOMC to leave its policy rates and asset purchases unchanged. We believe that neither economic nor financial conditions are bad enough that it is currently easing further Insurance policy is justified, “notes the Bank of America.
Diane Swonk, chief economist at Grant Thornton, said the Fed should keep its powder dry, not make changes, but provide guidelines for the conditions under which it would operate.
“I think they should wait to see if they have to pull the trigger. They are long-term bondholders. Once they leave, it will be harder to settle. You must have a good reason to do it.” ,” She said.
“I don’t think the Fed wanted to be in that position, but they didn’t define what they were up to clearly enough. Whatever we hear from them would give them the flexibility to do something by the end of the week, if the.” Congress goes home and doesn’t do anything. You don’t have to wait until January, “Swonk said.
Swonk expects the Fed to also change the way it looks at its economic forecast to create more context for the risks involved in the forecast. “You could have a revised higher forecast with more risks,” she said.
The Fed may find that the near-term outlook is weak due to the economic impact of the rising number of coronavirus cases across the country. However, there may be better prospects in the longer term because of the vaccines that are just being given.
The Treasury cut off the wings of the Fed by refusing to extend some of its contingency programs and instead diverted funds to fiscal stimulus. The municipal and corporate bond facilities and the Main Street loan program closed at year end.
But Fed watchers expect these programs could resume when the Fed takes over from Biden and former Fed chief Janet Yellen becomes Treasury Secretary if the Fed deems it necessary.
Rieder said the Fed was in a unique position with Yellen in the Treasury and they could form an important partnership.
“I think people understand that this is a big deal, especially as both will be reluctant. The economy can handle more housing and more taxes that are funded by the Treasury and the Fed,” he said.