Fed minutes: concern about near-term outlook, optimism about the medium-term

The minutes of the December 15-16 FOMC meeting revealed Fed members’ concerns about the near-term outlook for the economy and labor market, emphasis on the enhanced “maximum inclusive employment” objective, insights into the decision to update the forward guidance on large-scale asset purchases (LSAPs) and the flexibility to adjust these purchases in response to economic developments. The minutes reinforced the Fed’s decidedly dovish tilt and we continue to expect it to maintain its asset purchases and anchor interest rates to zero for the foreseeable future.

Fed members reiterated that the economic recovery had been stronger than anticipated, but that they expect the economy to slow in the coming months because of the worsening pandemic. They noted the upside risks to the medium-term outlook from widespread vaccinations that could release pent-up demand, ease social distancing, lift labor force participation, and boost spending. We forecast that U.S. economic growth will reaccelerate once this intense stage of the pandemic ebbs, with real GDP increasing by 5.0% in 2021 and regaining its Q4-2019 level by Q3-2021 (Forecasts at a glance, December 18, 2020).

The minutes showed that all Fed participants supported the decision to link its forward guidance on LSAPs to substantial further progress on its maximum employment and price stability goals. Fed participants view this enhanced forward guidance as: 1) better aligning with its outcome-based guidance on its policy rate; 2) offering better clarity on the role of LSAPs in meeting its goals; and 3) highlighting the responsiveness of its balance sheet policy to unexpected developments.

The Fed’s LSAPs have resulted in a massive $2.8 trillion increase in its balance sheet since mid-March 2020 and it continues to purchase $120 billion in securities per month ($80 billion per month in Treasury securities and $40 billion per month in mortgage-backed securities). Nearly all participants support maintaining the current composition of purchases, but a couple of participants expressed a willingness to purchase longer-maturity Treasury securities. Although the Fed has not provided any quantitative thresholds for this enhanced LSAP forward guidance, we expect the Fed to continue purchases at this current pace in the medium-term and consider tapering purchases only after real GDP has regained its pre-pandemic level. The minutes indicated that the tapering of its asset purchases would follow a sequence similar to the one implemented in 2013 and 2014.

In keeping with the Fed’s enhanced “maximum inclusive employment” goal, Fed members emphasized that COVID-19 has disproportionately affected certain groups. (In November 2020, the unemployment rate for White persons was only 2.8pp above its pre-pandemic level, but 4.0-4.5pp higher for other races -- see “U.S. labor market: big gains, big shortfalls”, December 9, 2020). With this new Fed strategy in which it is focused on shortfalls in employment and maximum inclusive employment, its policy is expected to be decidedly dovish. The Fed will maintain its ultra-easy monetary policy as long as labor markets are recovering and inflation remains moderate, which the Fed now views as moderately above 2%. However, further fiscal stimulus or higher bond yields could force some change (US bipartisan congressional fiscal legislation to support economy, December 21, 2020).

Roiana Reid, roiana.reid@berenberg-us.com

Member FINRA & SIPC
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