FOMC Preview: Restrained confidence at best?

Previous Fed action

The FOMC are due to keep both their policy rate and also the QE programme unchanged – that means unlimited and flexible. This comes after the Fed acted swiftly and decisively cutting rates to zero and announcing 11 different lending facilities to combat the impact of economic lockdown. The creation of these facilities had been a key plank of their efforts to stabilise markets and boost the economy, alongside the unprecedented expansion of its balance sheet through the purchase of trillions of dollars of treasury bonds.

More recently the Fed has been making mild changes to these emergency policies with their Mainstream Lending Program finally coming on tap, while QE has been tapered from the $75bn per day of Treasury purchases scheduled at the peak to under $5bn for this coming week.

Green shoots

All of this has come on the back of some emerging improvement in recent data with strong mortgage approvals and car sales backed up by the ‘remarkable’ jobs report last Friday. Of course, equities have been front running this v-shaped recovery talk with the S&P500 bouncing back close to all-time highs while even longer-dated treasury yields couldn’t ignore the optimism, moving near to three-month highs.

However, it seems highly unlikely that a handful of more positive gauges and a slowing pace of contraction will push the Fed to move the dial. That dial is cautious at the moment as officials have generally chosen to highlight the economic and health uncertainties they see as still evident. A possible risk of a second virus wave and impaired credit risk feature in those fears, and a more complete employment report or two will no doubt be needed. Let’s not forget employment remains nearly 20 million below February’s level and the economy is expected to shrink by nearly 40% on an annualised basis in the second quarter of this year.

Additional action if needed

An updated dot plot, the first since the pandemic shock and December in fact, is due to be released and these forecasts will serve as guidance, even if the FOMC decides not to strengthen forward guidance compared to its ‘act as appropriate’ mantra to date. If there is one rate rise before the end of 2022, then this may finally put to bed speculation about negative rates.

But given the sell-off in fixed income, there may be discussion around yield curve control. This targets shorter term Treasury yields in order to guide longer term yields and would prevent borrowing costs rising too much too quickly. That said, 10-year yields are below 1% at present so hardly represent a significant growth headwind.

Budding signs of recovery relative to the risk it perceives in markets getting ahead of themselves is the key question for Powell at this meeting. A cautious optimism may be heard, but the FOMC will be wary of this initial reopening bounce subsiding and then a slower, more bumpy recovery. This benign environment will not dent the risk rally meaning the dollar should stay under pressure.