A heavily constrained Fed
We expect the Federal Open Market Committee (FOMC) to keep rates on hold when it meets this week, meaning the interest rate on banks’ excess reserves stays at 0.1%. Nor do we foresee any change to the Fed’s asset-buying programme. However, we expect dovish language from the FOMC, reflecting the recent flatlining in economic activity as coronavirus cases continue to escalate. In other words, the Fed is likely to signal that it continues to have its finger on the trigger, ready to ease policy even more if necessary. Indeed, we expect more accommodation in coming months, likely to take the form of more quantitative easing (QE) rather than negative interest rates.
Although the Fed rejects the claim that it is monetising the federal debt through its QE initiatives, the booming deficit, which is likely to expand further as a new fiscal package is prepared, is putting implicit pressure on the Fed to help ‘accommodate’ that borrowing.
Taking a step back, our prism for viewing Fed action remains that we are in a ‘debt dominance monetary regime’ strongly influenced by Modern Monetary Theory (MMT). The sharp accumulation in government and private debt will greatly constrain the Fed in coming years, making monetary normalisation elusive.
A spike in inflation is unlikely to come from the Fed’s QE or from low rates themselves, in our view. Rather, and more dangerously, it might come from a potential slide in confidence in money if policy continues its course towards a ’pure’ version of MMT, either in the form of direct injections of money into individual bank accounts, and/or the direct control of the Fed by the White House.
Our big picture thinking is that the Federal Reserve is heavily constrained by both the government and high market borrowing and that the Fed’s balance sheet is likely to stay bloated for a while, acting de facto as a debt defeasance and amortisation structure (for private and public debt).