What to expect from the Fed this week
The Federal Reserve meets this week (decision and press conference on 10 June). Rates are expected to remain on hold (i.e. the interest rate on excess reserves should stay at 0.1%). We think we could see some sort of yield control in the second half of the year, but nothing is imminent, in our view.
The focus will be on guidance about future tightening. We think the Fed will continue to kick that issue into the long grass due to the severity of the coronavirus economic shock. We still believe a Fed rate hike is in the distant future. The Fed has taken very ambitious steps during the coronavirus, including the use of the Treasury’s credit guarantee to buy corporate bonds and corporate bond ETFs, a step not taken during the global financial crisis.
Right now, the focus is on the Fed’s ‘Main Street Lending’ programme (loans to businesses via commercial banks). The programme has been slow to take off due to bureaucratic complexities (and banks’ involvement), and Powell may have to spend a lot of airtime reassuring the public about its deployment.
In fact, the Federal Reserve is increasingly interested in capping yields beyond the short rate in order to cement its promise not to hike rates for a while—but no announcement is likely this week. Rather than negative nominal rates, yield caps, as well as potentially more quantitative easing if necessary, are still the Fed’s preferred options.
We think Chairman Jerome Powell is likely to remain cautious about the US and global macro outlook despite some ‘green shoots’. The Fed’s forecast is likely to show unemployment remaining high—likely in the vicinity of 10% in Q4 2020—supporting its prudent stance on monetary policy.
Our alternative prism for viewing Fed action has not changed. We are in a ‘debt dominance monetary regime’ or ‘soft’ Modern Monetary Theory (MMT)-inspired policy regime. The sharp acceleration in government and private debt issuance in recent weeks only reinforces the point that elevated debt levels will constrain the Fed even further in coming years, making rate normalisation elusive.
Hyperinflation will only be a risk if the Fed moves to ‘pure’ MMT (which would include the Fed being placed under the White House’s direct control)—but we see this as unlikely.