Fed still likely to provide more accommodation - Capital Economics
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Fed still likely to provide more accommodation

US Economics Update
Written by Michael Pearce
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While the Fed left its policy settings unchanged and opted not to strengthen its forward guidance at the conclusion of its meeting today, its downbeat assessment of the economic outlook still suggests they will provide more accommodation in the months ahead. We think that will include a switch to some form of average inflation targeting in the coming months and perhaps a ramping up of asset purchases.

  • While the Fed left its policy settings unchanged and opted not to strengthen its forward guidance at the conclusion of its meeting today, its downbeat assessment of the economic outlook still suggests they will provide more accommodation in the months ahead. We think that will include a switch to some form of average inflation targeting in the coming months and perhaps a ramping up of asset purchases.
  • Unsurprisingly, the Fed left the fed funds rate unchanged at 0-0.25% and did not unveil any changes to its asset purchases, though the statement still hints at a possible scaling up of purchases in the future, saying purchases will continue “at least at the current pace”.
  • While the Fed has so far seen little need to add to the already considerable monetary stimulus in place, the policy statement did include new gloomy language on the economic outlook. While acknowledging that economic activity and employment had “picked up somewhat”, they still “remain well below” pre-pandemic levels. Officials also inserted a new line acknowledging that “the path of the economy will depend significantly on the course of the virus”. In the post-meeting press conference, Chair Jerome Powell doubled down on that point, calling the spread of the virus “the most central driver” of the economy, and said the renewed surge in cases had led to a “slowing in the pace of the recovery”. At the same time, he acknowledged the uncertainty, saying how large and how sustained that slowdown will be is unknowable.
  • The cautious statement, together with Powell’s comments, suggests the Fed is likely to provide more accommodation in the coming months. While stressing that additional help from fiscal policy is essential, he said “more will be needed from all of us” and cited adjusting its forward guidance, increasing asset purchases, or tweaking its 13(3) lending programs as three ways the Fed could loosen policy further.
  • The Fed already announced yesterday that it would extend its section 13(3) lending programs which were previously set to end in September until the end of the year. That was unsurprising, given the uncertainty over whether there will be a renewed wave of infections in the fall. The bigger question is how the Fed will respond if the take-up of its lending facilities remains disappointing. (See Chart 1.) We suspect the Fed will either ramp up its corporate bond purchases in the corporate credit program, or pivot to buying more Treasury securities in the coming months and direct its purchases to the longer end of the curve. The latter is unlikely to make much difference when longer-term Treasury yields are already so low. (See Chart 2.)
  • It was perhaps a slight disappointment that the Fed chose not to strengthen its forward guidance on interest rates at this meeting, but that may just be a matter of timing. Officials resumed their year-long review of monetary policy strategy at this meeting, which had been due to wrap up this summer, but has been postponed due to the pandemic. While Powell had no details to share, he confirmed it would conclude in the “near future”. We expect that review to result in a shift towards a form of average inflation targeting which, in the context of a decade of below-target inflation, would be a strong signal that policy will remain looser for longer than otherwise. It would make sense to tie changes in forward guidance with the unveiling of its new strategy. The upshot is that we expect more from the Fed in the coming months.

Chart 1: Fed’s 13(3) Lending Programs ($bn)

Chart 2: Treasury Yields (%)

Source: Refinitiv


Michael Pearce, Senior US Economist, +1 646 583 3163, michael.pearce@capitaleconomics.com