Fed Keeps Pedal to Metal

As discussed yesterday, last night we saw the much anticipated March meeting of the US Federal Reserve, the first coinciding with the anniversary of the COVID crisis that saw them unleash unprecedented easy monetary policy and the first since yields in US Treasuries started rising materially.  As the Bloomberg headlines says this morning “Powell Holds Dovish Line as Fed Signals Zero Rates Through 2023”, the question on everyone’s lips of whether they would be dovish or hawkish was firmly answered in the dovish, or more easy monetary policy, affirmative. 

Whilst no one expected any immediate change to rates or QE, all eyes and assumptions were on the so called Summary of Economic Projections (SEP) or Fed Crystal Ball for clues on when we might expect the easy money game to start to tighten.

In simple terms nothing changed.  Zero rates are projected until 2024 and QE to continue despite a markedly increased GDP growth projection of 6.5% in 2021.  That may well seem incongruous to you but such is the depth of the hole they are trying to get out of.  Remember 6.5% up on a much smaller number is still a small number.  Likewise the QE program of $120 billion a month will be maintained until “substantial further progress” on employment and inflation is sustainably achieved. 

They see inflation initially increasing beyond 2% this year but back to 2% after that fiscal stimulus blip and the US still has 9.5m fewer people employed than a year ago.  And so they are keeping the pedal to the metal.

Many in the market were wanting to hear what would happen to the so called Supplementary Liquidity Ratio (SLR) which measures in percentage terms a bank’s ability to take losses on its assets.  When COVID hit, the Fed granted relaxations to the big banks to allow for, you guessed it, more loans and debt.  That holiday is set to end at the end of this month and if it did it would see the banks having to offload a massive amount of US Treasuries which would then drive yields back up after the Fed jawboned them back down last night.  Powell wouldn’t answer the question last night but said “we'll have something to announce on SLR in coming days”.  The market predictably took that as ‘we will extend it’ and off it went.

For investors this of course all means the bubble gets bigger and the size of the inevitable bursting along with it. Below is a longer and quite good summary of last night from Goldman Sachs who also had to admit they were one of many who got it wrong in calling for a hawkish meeting and a rate rise in 2023.

“1. The FOMC left the funds rate target range unchanged at 0–0.25% and left the policy outlook characterization and asset purchase policy unchanged. The statement’s characterization of the current economic situation continued to emphasize the effect of COVID-19 on economic activity and was updated to acknowledge that the pace of the recovery has “turned up recently” after previously moderating. The Committee also removed the language on oil prices “holding down”inflation and now more plainly states that “inflation continues to run below 2%.” In the implementation note, the FOMC increased the counterparty limit on overnight reverse repurchase agreements from $30bn to $80bn.

2. The median projected path for the policy rate in the Summary of Economic Projections (SEP) continued to show no change over the forecast horizon, against our expectations for one hike in the SEP. However, FOMC participants expressed divergent views, as six of the seven participants that expected at least one hike by the end of 2023 projected multiple hikes (vs. five previously with one or more hike;we had expected eleven at this meeting). Additionally, four participants showed a hike at the end of 2022 (vs. one previously; we had expected two at this meeting). The median longer run projection for the fed funds rate was unchanged at 2.5%, as expected.

3.Likely reflecting the American Rescue Plan Act and improvement in the public health situation, the GDP projections in the SEP were increased substantially, with the median growth projection for 2021 raised 2.3pp to 6.5% (median growth projections for 2022 and 2023 were little changed: +0.1pp and -0.2pp, respectively).But while the 2021 core inflation median increased sharply (+0.4pp to 2.2%), the median participant did not project much overheating in the medium-term: the 2023unemployment rate median fell only 0.2pp (to 3.5%), the longer-run unemployment rate median was surprisingly revised down (-0.1pp to 4.0%), the 2023 core inflation median rose 0.1pp to 2.1%, and only one participant projected core inflation rising above 2.2% over the forecast horizon.”