Federal Reserve Chairman Jerome Powell speaks to reporters after the Federal Reserve cut interest rates in an emergency move designed to shield the world’s largest economy from the impact of the coronavirus, during a news conference in Washington, March 3, 2020.
Kevin Lamarque | Reuters
Fed Chairman Jerome Powell’s gloomy view of the economy has markets looking for more guidance on what the central bank will do next to help prop it back up.
Some strategists believe the Fed could announce a new quantitative easing program of a set size or pace before or at its June 9-10 meeting. Quantitative easing was first used by the Fed during the Great Recession and became known as QE.
Powell, in a webinar Wednesday, also knocked the idea of negative interest rates, which had been speculated about in the market. Last week for the first time ever, fed funds futures implied a negative fed funds rate. After his comments, the futures rose slightly but still implied slightly negative rates, starting next March.
Powell called negative yields, used in Europe and Japan, an “unsettled” policy and said it’s not clear whether there are benefits, though it hurts banks and their ability to lend.
Selling in stocks gained momentum after Powell’s comments about the economy, and Treasury yields were steady at lower levels. Strategists said fed funds futures were likely responding to technical trading and hedging.
Mark Cabana, head of U.S. short-rate strategy at Bank of America, said it was positive that Powell knocked the idea of negative rates but the chairman didn’t go into detail about other things the Fed could do.
“He talked about challenges with financial intermediation. He didn’t say never, ever, ever but he say the Fed’s thinking about negative rates has not changed, and they would like to utilize other tools, and that’s going to be the focus. We know generally what those tools are but what I want to know is how is the Fed thinking about forward guidance, what type of terms would they utilize with forward guidance and how they are thinking about asset purchases?” Cabana said.
The Fed has been buying Treasurys and mortgage-backed securities in an effort to keep markets liquid, and it has been adjusting the amount on a weekly basis. But strategists say the Fed’s next step should be to create a longer-term program, structured like past QE programs, with either a set size or pace.
Powell did say other policy moves may be necessary, and the economy may need more help through fiscal stimulus, which would have to be authorized by Congress. “Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery,” Powell said.
To pay for fiscal programs to fight the virus, the Treasury has dramatically boosted its borrowing, announcing it will borrow a record $3 trillion this quarter. At the same time, the Fed has boosted its balance sheet to $6.7 trillion through asset purchases. The market has expected the Fed to help smooth the way for Treasury issuance by purchasing a steady flow of assets in that market.
“It’s possible they announce something before the June meeting, given that [the Treasury market] absorbed the increase in supply quite well,” said Jon Hill, BMO fixed income strategist. “Treasury dramatically increased auction size, and the 10-year yields are still at 64 basis points. I don’t think there’s an urgency to force a QE before June, but it seems that type of guidance will come by the June meeting at the latest.”
Powell’s description of the economy was bleak, saying it caused “a level of pain that is hard to capture in words.” Powell also said a recovery is dependent on the virus, how long it will take to develop treatments and whether the economy can rebound despite the limitations of social distancing. It will also depend on whether there are new outbreaks.
“I think he’s just being realistic. The S&P 500 is at a 20 P-E. I’m not a stocks guy but that’s hard to justify,” said Hill.
Hill said the Fed’s current asset purchase program, which it adjusts nearly weekly, could turn into a more traditional QE program.
“What they’ve been doing is more liquidity based,” said Blake Gwinn, U.S. rate strategist at NatWest Markets. When markets seized up in March, the Fed jumped in and helped provide liquidity. The central bank also has cut the fed funds target rate to near zero, and it has announced other policy moves, such as a lending program for businesses and facilities aimed to help markets for commercial paper, corporate debt and municipal bonds.
Many market pros consider the Fed’s current asset purchases a type of QE, but the Fed has made it clear it was not the same. The current program is open-ended, not the type of QE used in the Great Recession.
Gwinn said the Fed, now buying about $7 billion a day in Treasurys, should target longer-duration securities, like 10-year and 30-year bonds. The Fed could also use its announcement of a program to reassure investors that it would not be adjusting its rate policy any time soon.
“They’re buying across the curve and they’re announcing it on a week-to-week basis. …To really get stimulus out of asset purchases you want that big shock effect. You want that removal of duration the way those big liquidity programs don’t really accomplish. When you only know what they’re buying a week from now, they’re not really focused on the long end,” said Gwinn. “Those purchases should be focused on the long end. You want to remove the longer duration securities to get the portfolio rebalance and lower long-term borrowing rates to stimulate the economy. That’s in theory where you would get more stimulus. There’s also a communications aspect of it.”
Hill said the Fed could adjust its program down to about $5 billion a day of Treasury purchases, or about $100 billion a month.
“The question is when does the FOMC confirm that that will be the pace going forward,” Hill said. “Up until now the issuance has been so heavy in the front end that there’s an argument to include bills to help with market function.” But he said QE is intended to encourage risk, so it could target Treasury notes of five-year duration or longer.