Fed minutes: remain ultra-easy and develop a flexible strategic framework that fits

The minutes of the July 28-29 FOMC meeting revealed that the Fed: 1) wants to finalize changes to its Statement on Longer-Run Goals and Monetary Policy Strategy soon to guide its policy actions and communications; 2) remains committed to using its toolbox to support the economy and maintain financial stability; and 3) intends to maintain ultra-easy monetary policies by keeping the Fed funds rate near its effective lower bound (ELB) and continuing large-scale asset purchases (LSAPs) at least at the current pace.

Fed members discussed potential changes to its Statement on Longer-Run Goals and Monetary Policy Strategy at the July FOMC meeting, but the details were not revealed in the minutes. We expect the longer-run strategy to be updated to reflect the Fed’s intention to achieve 2% inflation on average in support of its “symmetrical” 2% inflation target, but be worded in a way that allows the Fed to maintain full discretion over monetary policy and also gives the clear impression that the Fed favors inflation above 2%. (“Favors” conveys a more dovish signal about the Fed’s conduct of monetary policy than “would tolerate” or “would allow”.) This would represent a shift from its past strategy of tightening monetary policy before (and in anticipation of) an acceleration in inflation.

The Fed continued to discuss a revamp of the forward guidance in its Official Post-FOMC Meeting Policy Statement. It is debating whether to tie the Federal funds rate to inflation outcomes, unemployment rate outcomes, combinations of both, or combinations with calendar-based guidance. We note that following the financial crisis of 2008-2009, the Fed’s efforts to tie monetary policy to guidelines—either time schedules or the unemployment rate—did not work as planned, and it will be very cautious in doing so again.

Reflecting the Fed’s commitment to symmetric 2% inflation and likely several years of the Fed funds rate at its effective lower bound (ELB), members noted “that a highly accommodative stance of monetary policy would likely be needed for some time to support aggregate demand and achieve two percent inflation over the longer run.”

The minutes suggested that Fed members are unlikely to adapt yield curve caps and targets as an additional monetary policy tool. Most Fed members are concerned about the downside risks of adopting yield curve control relative to any benefits they may provide, but a few members believe yield curve caps would reinforce guidance on the Fed’s asset purchases and possibly help limit the amount of asset purchases that it would need to make.

The Fed has not yet provided any indication of its intention to end its LSAPs of Treasuries or MBS. Its LSAPs have totaled $2.4 trillion since mid-March and it has committed to maintaining LSAPs at least at their current pace over the coming months. Several Fed members noted that LSAPs which were initially designed to support financial market functioning were likely also providing some policy accommodation. Several noted that additional accommodation could be required given the increase in uncertainty about the economic outlook.

Fed members noted that the ongoing liquidity and lender of last resort (LOLR) facilities had contributed to the sustained improvement in financial market functioning since March and that as a result of increased availability of short-term funding, borrowing at its liquidity facilities had stayed low in recent months. To date, the LOLR facilities’ asset purchases have been very small compared to LSAPS. LSAPs account for 89% of the $2.6 trillion increase in the Fed’s balance sheet since mid-March, and the Fed has purchased only $12 billion corporate bonds and bond ETFs through August 12 and extended only $226 million through its Main Street Lending program.

Fed members expressed concern about the elevated uncertainties surrounding the economic outlook and risks including additional waves of COVID-19 outbreaks, insufficient fiscal support for households, businesses, and state and local governments, and greater-than-expected pressure for foreign economies. A number of participants noted the risks to financial stability from banks and other financial institutions if adverse economic scenarios are realized and nonfinancial corporations’ high levels of indebtedness. Interestingly, a couple of Fed members stated that they are in favor of the Fed extending its restrictions on banks’ shareholder payouts, but another member said that would be premature. There were also concerns about the implications for market functioning of the anticipated increase in Treasury debt.

Fed members highlighted the uneven economic impacts of this crisis on lower-wage and service-sector workers, many of whom are minorities and women and the need for additional fiscal aid to support vulnerable families and the broader economy.

Mickey Levy, mickey.levy@berenberg-us.com

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

Member FINRA & SIPC
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