Fed moves closer to offering interest rate guidance

Federal Reserve officials moved closer to offering detailed guidance on the path of interest rates and asset purchases last month as they discussed reinforcing their policy tools in response to the recession triggered by the coronavirus pandemic.

According to minutes from the Federal Open Market Committee meeting held on June 9 and 10, there was a growing consensus within the central bank that the Fed should “further clarify” its monetary policy intentions, though no firm timeline was given for such a move.

“Most participants commented that the committee should communicate a more explicit form of forward guidance for the path of the federal funds rate and provide more clarity regarding purchases of Treasury securities and agency mortgage-backed securities as more information about the trajectory of the economy becomes available,” the minutes said.

The minutes indicated that “a number” of participants “spoke favourably” about tying forward guidance to inflation outcomes.

“They saw this form of forward guidance as helping reinforce the credibility of the committee’s symmetric 2 per cent inflation objective and potentially preventing a premature withdrawal of monetary policy accommodation,” the minutes said.

Others saw a benefit in using the unemployment rate as the key metric, meaning the Fed would not raise rates until joblessness fell to a certain level, while another group suggested a “calendar-based” approach.

Fed officials also discussed in detail the applicability of a policy last used during the second world war called yield curve control, which involves the Fed setting targets for Treasury yields. It then buys or sells as many government bonds as needed to maintain those levels.

Japan and Australia are among the other central banks to currently employ the policy, with the Bank of Japan targeting 10-year government bond yields and the Reserve Bank of Australia focusing on three-year yields.

Fed officials saw the Australian experience as “most relevant for the current circumstances” in the US, but the minutes show there still remains some concern about the risks to such a policy.

US Treasuries sold off after the release of the minutes, sending the yield on the benchmark 10-year note higher by 0.03 percentage points to 0.68 per cent.

Pressure on the Fed to offer firmer guidance on monetary policy has been muted by the fact that its top officials are not projecting any rate increase until at least the end of 2022. Jay Powell, the Fed chair, has said the central bank was not “thinking about thinking” about tightening policy. But as time passes, the Fed might face more calls to be more explicit about its plans.

The FOMC meeting in June was held in the midst of widespread protests against racial injustice across many US cities — a topic that was addressed by Mr Powell as he opened the gathering.

It also came after a surprisingly encouraging jobs report for May, which suggested the economy was bouncing back earlier than expected. While FOMC officials said it was “positive news”, they noted that the it was “too early to draw any firm conclusions” about the economic trajectory.

“Prospects for further substantial improvement in the labour market were seen as depending on a sustained reopening of the economy, which in turn depended in large part on the efficacy of health measures taken to limit the effects of the coronavirus,” the minutes said. “On this issue, participants judged there to be a great deal of uncertainty and expressed concerns about the possibility that an early reopening would contribute to a significant increase of infections.”

Since the last FOMC meeting, new spikes in coronavirus infection across a range of populous southern and western states, including Florida, Texas and California, have alarmed health officials and caused local officials to pause or roll back the lifting of restrictions on economic activity, posing a new challenge to the outlook. 

Appearing before the Congress this week, Mr Powell touted the swifter-than-expected rebound in some economic indicators, including employment, but warned that a full recovery was still far away and the trajectory of Covid-19 in the US remained a concern. 

“We have entered an important new phase and have done so sooner than expected,” Mr Powell told the House financial services committee. “While this bounceback in economic activity is welcome, it also presents new challenges — notably, the need to keep the virus in check.”

The Fed has been able to engineer a robust rebound in financial markets that were wracked by fierce volatility and intense selling pressures in March and April. 

Buoyed by the central bank’s pledge to pump trillions of dollars into the financial system to ward off a more pronounced crisis, investors have stampeded into riskier assets.

The S&P 500 has surged more than 20 per cent over the past three months in what has been its strongest quarter since 1998. Meanwhile, borrowing costs for US corporations have plummeted, encouraging cash-strapped companies to access much-needed financing at a record pace.

Investors see a limit to this rally, however, should the economic backdrop fail to improve further due to renewed concerns about the virus, or if Congress fails to renew some of the fiscal support it provided since the start of the crisis to unemployed workers, struggling families, and small businesses.

“The Fed can’t do it alone,” said David Brown, co-head of global investment-grade fixed-income at Neuberger Berman.