Friday's Market Minute: FOMC Guidance And Other Side Of COVID-19

The December FOMC meeting concluded largely as expected, with the Fed providing some additional guidance around the asset purchase program but declining to make changes to the program at this time.

As stated, the Federal Reserve will “continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”

When reading the statement, note “further progress” does not necessarily mean complete progress; therefore, one can infer the Fed will rein in the asset purchase program before raising interest rates. The investment community seeks answers to questions, such as when and under what conditions will the Fed begin to taper the $120 billion monthly QE program? Powell did not explicitly provide a timeline, but did indicate a provision of advance notice. As an investor, I expect that notice to begin next year if the economy looks to rebound strongly as expected by mid-2021.

The updated guidance on asset purchases is explicitly linked to economic outcomes, and we have no reason now to think the Fed will pull back on the asset purchase program until the economy shows substantial further improvement. Economic activity and employment have continued to recover, but remain well below their levels at the beginning of the year. Weaker demand, stagnant wages, and earlier declines in oil prices have been holding down costs and inflation.

Even though the Fed sees unemployment dropping close to its estimate of the longer run rate, 4.1%, at the end of 2022, this improvement has no bearing on the decision to raise or not raise policy rates. The Fed needs to see actual inflation sustained moderately above 2% to justify a rate hike. With no such inflation expected, no rate hike is forecast.

COVID-19 is akin to a natural disaster, where the most significant impacts occur in a narrow time horizon. By making comparison to this past spring regarding the economy, the pandemic shock is much smaller and the speed of recovery on the other side is becoming clearer. The other side now has a vaccine, allowing for even quicker recovery. Financial markets reveal no signs of distress, and are instead are very well accommodated by the Fed.

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