Jeff Cox



The Federal Reserve is completing a yearlong policy review and is expected to announce the results soon.
One big change would be a harder commitment to getting inflation higher, through a pledge not to raise rates until it hits at least 2%.
Markets have been betting on higher inflation, with surging gold prices, a falling dollar and a rush to inflation-indexed bonds.

In the next few months, the Federal Reserve will be solidifying a policy outline that would commit it to low rates for years as it pursues an agenda of higher inflation and a return to the full employment picture that vanished as the coronavirus pandemic hit.

Recent statements from Fed officials and analysis from market veterans and economists point to a move to “average inflation” targeting in which inflation above the central bank’s usual 2% target would be tolerated and even desired.

To achieve that goal, officials would pledge not to raise interest rates until both the inflation and employment targets are hit. With inflation now closer to 1% and the jobless rate higher than it’s been since the Great Depression, the likelihood is that the Fed could need years to hit its targets.

The policy initiatives could be announced as soon as September. Addressing the issue last week, Fed Chairman Jerome Powell said only that a yearlong examination of policy communication and implementation would be wrapped “in the near future.” The culmination of that process, which included public meetings and extensive discussions among central bank officials, is expected to be announced at or around the Federal Open Market Committee’s meeting.

Markets are anticipating a Fed that would adopt an even more accommodative approach than it did during the Great Recession.

“We remain firmly of the view that this is a deeply consequential shift, even if it is one that has been seeping into Fed decision-making for some time, that will shape a different Fed reaction function in this cycle than in the last,” said Krishna Guha, head of global policy and central bank strategy at Evercore ISI.

Indeed, Powell said the policy statement will be “really codifying the way we’re already acting with our policies. To a large extent, we’re already doing the things that are in there.”

Guha, though, said the approach “would be sharply more dovish even than the strategy followed by the [Janet] Yellen Fed” when the central bank held rates near zero for six years even after the end of the Great Recession.

All in on inflation

One implication is that the Fed would be slower to tighten policy when it sees inflation rising.

Powell and his colleagues came under fire in 2018 when they enacted a series of rate increases that eventually had to be rolled back. The Fed’s benchmark overnight lending rate is now targeted near zero, where it moved in the early days of the pandemic.

The Fed and other global central banks have been trying to gin up inflation for years under the reasoning that a low level of price appreciation is healthy for a growing economy. They also worry that low inflation is a problem that feeds on itself, keeping interest rates low and giving policymakers little wiggle room to ease policy during downturns.

In the latest shot at getting inflation going, the Fed would commit to enhanced “forward guidance,” or a commitment not to raise rates until its benchmarks are hit and, in the case of inflation, perhaps exceeded.

In recent days, Fed regional Presidents Robert Kaplan of Dallas and Charles Evans of Chicago have expressed varying levels of support for enhanced guidance. Evans in particular said he would like to keep rates where they are until inflation gets up around 2.5%, which it has not been for most of the past decade.

“We believe that the Fed publicly would welcome inflation in a range of 2% up to 4% as a long overdue offset to inflation running below 2% for so long in the past,” said Ed Yardeni, head of Yardeni Research.

The market weighs in

The investing implications are substantial.

Yardeni said the approach would be “wildly bullish” for alternative asset classes and in particular growth stocks and precious metals like gold and silver. Guha said the Fed’s moves would see “real yields persistently lower, the dollar lower, volatility lower, credit spreads lower and equities higher.”

Investors have been making heavy bets that would be consistent with inflation: record highs in gold, sharp declines in the U.S. dollar and a rush into TIPS, or Treasury Inflation Protected Securities. TIPS funds have seen six consecutive weeks of net inflows of investor cash, including $1.9 billion and $1.5 billion respectively during the weeks of June 24 and July 1 and $271 million for the week ended July 29, according to Refinitiv.

Still, the Fed’s poor record in reaching its inflation target is raising doubts.

“If there’s any lesson that should have been learned by all the world’s central banks it’s that picking an inflation target is easy. Trying to actually get there is extraordinarily difficult,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “Just manipulating interest rates doesn’t mean you get to some finger-in-the-air inflation rate that you choose.”

Boockvar doubts the wisdom of wanting to crank up inflation at a time when unemployment is so high and the economic recovery in jeopardy.

“It doesn’t make any economic sense whatsoever,” he said. “The consumer is very fragile right now. The last thing we should be shooting for is a higher cost of living.”

Author: Jeff Cox

Source: CNBC: The Fed is expected to make a major commitment to ramping up inflation soon


Should market conditions deteriorate, the Federal Reserve could venture into the stock market, several market analysts and economists said.
Such a move likely would come in the form of a big ETF that tracks major market indexes.
Congressional approval would be needed to take such a step.
The Fed already has launched a historically aggressive use of its various powers.

The Federal Reserve has unleashed what’s frequently been called a bazooka in its efforts to calm markets. Its next step could be to go nuclear.

Should conditions on Wall Street deteriorate significantly, the central bank could go where it’s never gone before: to passively intervene in the stock market for the first time ever, according to market analysts and economists.

The Fed already has unloaded an unprecedented level of ammunition against the tumult brought on by the coronavirus, so doing more would take it even further into uncharted waters.

However, interviews with a variety of market pros over the past week showed that the idea of the Fed venturing into the stock market seems anything but far-fetched. The Fed would need congressional permission to extend its operations, but it already has received wide latitude from the Treasury Department through emergency provisions in the Federal Reserve Act.

“If there were any major dislocations, it is clear that they will go into whatever nook and cranny in the market that starts to choke,” said Quincy Krosby, chief market strategist at Prudential Financial. “We know that when you have choking in one part of the market, you have choking in another part of the market that leads to dislocation. As soon as you cross that line, you are now facing something else that you could conceivably buy.”

Indeed, the Fed already has shown a willingness to go beyond its financial crisis response, and it may have to do more if the crisis worsens.

As the economic fallout from the pandemic spread earlier this month, Boston Fed President Eric Rosengren already was saying the Fed may need to broaden the types of assets it can buy to support the economy.

“We should allow the central bank to purchase a broader range of securities or assets,” Rosengren said March 6 at a meeting of the Shadow Open Market Committee, a board of economists who watch over Fed activities.

Corporate bonds, unlimited QE

In cutting its benchmark interest rate to near zero, where it was during the financial crisis, the Fed also announced it will begin buying corporate bonds. Though the focus will be on investment-grade stable companies, the move represented another step into risk and comes along a similar foray into the municipal bond market.

On top of all that, the Fed has gone from a limited plan to buy Treasurys and mortgage-backed securities through the fourth round of its quantitative easing program into an uncapped effort to keep buying as long as there’s a need.

Going beyond all those steps and dipping into one of the riskiest parts of the capital markets would have seen like fantasy only a few months ago. But a lot has changed.

“Nothing is out of the question. The question is, will it be needed? Has the Fed done enough to stabilize markets to ease stress so markets can function normally and properly,” Krosby asked, adding that “another major round of redemptions” in the fund market might be enough to get the Fed’s attention. “Everything is on the table now that was not even a potential six weeks ago.”

Such a move by the Fed likely would come via the $3.6 trillion exchange-traded funds market. That’s where the Fed is going for its intervention in corporate bonds as ETFs allow the central bank the ability to track an index rather than pick individual company bonds to own. ETFs are passive instruments in that they follow indexes like the S&P 500 and the Dow Jones Industrial Average instead of picking individual stocks.

While ETF trading has remained liquid through this crisis, investors have been pulling out in droves, though the redemptions last week were focused more on the bond market than stocks. A rally unlike anything the market had seen since the 1930s helped bring some cash into the equity market, but Wall Street ended with a thud Friday and more volatility is likely ahead.

Over the past month, the iShares Core S&P 500 ETF, a popular fund used to get broad exposure to large-cap stocks, saw its size drop by nearly a third as investors pulled about $5.2 billion from what is now an $11.8 billion fund. Continued moves like that are bound to get the Fed’s attention.

Following Japan
“Other central banks have done it. It’s the ETF route that the Bank of Japan has taken,” said Vincent Reinhart, chief economist and macro strategist at BNY Mellon Asset Management. “I would not rule out them doing equities.”

Indeed, the Bank of Japan’s move into equity ETFs would be something of a template for the Fed.

The BOJ has been an aggressive buyer of equity funds, with its total holdings around $256 billion in U.S. dollar terms at the end of the fourth quarter in 2019. That represented as much as 80% of the total market, something that has brought the bank criticism as the nation’s economy continues to limp along and as the holdings have come under pressure during the steep global market drop.

However, the BOJ is ramping up its purchases, which will now equal more than $110 billion annually.

“One of the questions asked most frequently is, isn’t the Fed out of ammunition? No, they still have plenty of tricks in their bag. Moving into further purchases of risk assets is one of the things they could do,” said Lauren Goodwin, economist and multi-asset portfolio strategist at New York Life Investments.

One risk for the Fed would be a perception that it’s overstepping its essential role as a a bank regulator with additional mandates to promote full employment and price stability. However, it already has shown a willingness to take extraordinary measures in times of crisis despite the risk of moral hazard.

“There’s a reason why the government has not wanted this perception of the central bank owning risk assets in the past,” Goodwin said. “But if a liquidity crisis turns into a solvency crisis and we still don’t have the facilities coming in to support the economy, then, yes, I think you could see the Fed be creative.”

The Fed is working closely with the Treasury Department on its various liquidity programs for the financial system as well as large and small businesses and households.

During the financial crisis, Treasury took equity warrants in troubled banks like Citigroup and Bank of America and then made money when it sold them. Treasury Secretary Stevne Mnuchin said Sunday morning on CBS’ “Face the Nation” that the government once again could take warrants or equity stakes if necessary.

Whether the Fed would take a stake in the equity markets, though, likely would require a steeper deterioration in stocks.

“We’ve seen the Fed show that they’re willing and able to do whatever it takes to make sure the markets are opening in an efficient manner. They’re taking whatever steps they can,” said Lindsey Bell, chief investment strategist at Ally Invest. “That would be new territory for the Fed, not that they’re scared of new territory.”

Author: Jeff Cox

Source: CNBC: ‘Nothing is out of the question’: What it would take for the Fed to start buying stocks

With the final 2019 meeting of Federal Reserve policymakers just two weeks away, Chairman Jerome Powell signaled that interest rates are unlikely to rise anytime soon, saying Monday that the central bank remains firmly committed to meeting its inflation goals.

The Fed considers a 2% inflation rate to be a sign of sustainable growth and a level that keeps interest rates high enough to allow for mobility in the event of an economic downturn. However, inflation has run well below that level for 2019 despite three interest rate cuts over the past four months.

In a speech in Providence, Rhode Island, Powell expressed a sense of urgency in meeting the inflation part of the Fed’s dual mandate. He said low inflation expectations feed on themselves and make it tougher for the Fed to support the economy.

The chairman said in prepared remarks that “it is essential that we at the Fed use our tools to make sure that we do not permit an unhealthy downward drift in inflation expectations and inflation. We are strongly committed to symmetrically and sustainably achieving our 2 percent inflation objective so that in making long-term plans, households and businesses can reasonably expect 2 percent inflation over time.”

A symmetric goal means policymakers would be content with inflation running a little above or below 2%. Other Fed officials have said that a period of time above 2% would be fine, with some members suggesting the Fed make an express commitment not to raise rates until the goal is met. Higher rates are used to keep inflation low.

The Fed’s next policy meeting is Dec. 10-11.

Focus on the labor market

Broadly speaking, Powell repeated language he and other officials have used lately, saying he sees “the current stance of monetary policy as likely to remain appropriate” and “well positioned” so long as current “generally good” conditions persist. The Federal Open Market Committee at its October meeting cut its benchmark rate another quarter point to a range of 1.5%-1.75%.

“At this point in the long expansion, I see the glass as much more than half full. With the right policies, we can fill it further, building on the gains so far and spreading the benefits more broadly to all Americans,” he said.

In addition to the inflation commitment, Powell also elaborated on another issue that has gained more attention in recent days, namely the still-low labor force participation rate in the U.S. as well as the fairly muted wage gains.

While the current labor force participation level is 63.3%, the highest in more than six years, Powell said it still is low compared with other countries and is another area of focus the Fed could use to ensure that the benefits of the decade-long recovery are spread more evenly. The prerecession participation rate was above 66%.

Powell said the Fed can help the participation and wage issues “by steadfastly pursuing our goals of maximum employment and price stability” though he said broader programs to support higher wages and a more engaged labor force are “beyond the scope of monetary policy” and more suited to legislators in Congress.

“These policies could bring immense benefits both to the lives of workers and families directly affected and to the strength of the economy overall,” he said.

Author: Jeff Cox

Source: CNBC: Powell says the Fed is ‘strongly committed’ to 2% inflation goal, a sign that rates are likely to hold steady

The Federal Reserve approved an expected quarter-point interest rate cut Wednesday but indicated that the moves to ease policy could be nearing a pause.

In a vote widely anticipated by financial markets, the central bank’s Federal Open Market Committee lowered its benchmark funds rate by 25 basis points to a range of 1.5% to 1.75%. The rate sets what banks charge each other for overnight lending but is also tied to most forms of revolving consumer debt.

It was the third cut this year as part of what Fed Chairman Jerome Powell has characterized as a “midcycle adjustment” in a maturing economic expansion.

Along with the decrease came language pointing to a higher bar for future easing.The FOMC removed a key clause that had appeared in post-meeting statements since June saying it was committed to “act as appropriate to sustain the expansion.” Powell had used the phase in early June to tee up the July rate cut, and it has been incorporated into the official language since.

In its place was more tempered language.

“The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate,” the statement said.

Fed Chair Jerome Powell was even clearer in a news conference, saying central bank officials “see the current stance of monetary policy as likely to remain appropriate.

Market participants had been looking for whether the Fed might start to signal that the policy accommodation, which had come following nine rate hikes since December 2015, would be winding down. The new language suggests an increased level of data dependence rather than an ongoing intent to adjust rates lower. While market pricing had been around 100% for a cut at this meeting, traders had seen only about a 25% probability of a move at the Fed’s next meeting on Dec. 10-11, according to CME data heading into Wednesday’s decision.

In their public speeches, Powell and multiple other Fed officials have characterized the U.S. economy as strong, led by solid consumer spending but threatened by exogenous factors such as global weakness, the U.S.-China tariff war and uncertainties associated with Brexit.

Other changes to statement

The statement continued to view the labor market as one that “remains strong” and economic activity as “rising at a moderate rate.” Descriptions of virtually all other benchmarks of activity remained unchanged, though the committee made a minor tweak regarding business fixed investment and exports to note that they “remain weak.”

The decision comes the same day that the government reported GDP growth of 1.9% that, while reflecting a deceleration, was above Wall Street estimates for 1.6%. Job gains, meanwhile, have slowed in recent months but are well above the 109,000 or so that the Atlanta Fed estimates are necessary to keep the unemployment rate at the 50-year low of 3.5%.

In addition to the solid performance in the jobs market and in consumer spending, stock market averages are around new highs.

Within the Fed, there has been disagreement about whether additional cuts are needed. Regional presidents Esther George of Kansas City and Eric Rosengren of Boston again voted against a reduction, with both maintaining that the committee should have held the line at the previous rate.

President Donald Trump, on the other hand, has pushed hard for the Fed to keep cutting rates and to resume the quantitative easing program the central bank used during and after the financial crisis to stimulate the economy.

The Fed has been buying bonds again, but officials insist it is an effort to stabilize the funds rate within the target range rather than a resurrection of QE. Still, the central bank balance sheet has expanded by about $100 billion over the past month and is back above the $4 trillion mark, $3.6 trillion of which is in Treasurys and mortage-backed securities.

The expansion was due mostly to growth in Treasurys and T-bills.

Wednesday’s statement reflects the recent balance sheet expansion, noting that open market operations will continue at least into the second quarter of 2020, while term and repo operations aimed at stabilizing overnight markets will continue at least through January.

Author: Jeff Cox

Source: CNBC: Fed cuts interest rates, but indicates a pause is ahead

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