Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Fed Preview: Powell’s masterclass on central bank navigating in period of crisis
Christopher Dembik
Head of Macroeconomic Research
Summary: The Federal Reserve is scheduled to announce its latest policy decision today at 6:00 p.m. GMT. We do not expect any major policy changes. Attention will likely shift to the central bank's nine liquidity facilities and the sharp increase in its balance sheet.
Context: Early this week, the Fed has expanded the scope and the duration of the Municipal Liquidity Facility in order to buy debt from counties and states with population of at least 500,000. The central bank will lend up to $500bn through the facility. Since the first week of March, the Fed has reacted fast and strongly to the crisis. It is basically engaged in unlimited QE to make sure the dollar funding market does not freeze. It has lowered the level of interest rate to all-time low between 0-0.25% and announced several credit support programs to help Main Street and Wall Street to cope with the crisis (see our G7 Policy Tracker for further details). As a result of all these measures, the Fed’s balance sheet increased by over $2.3tr in less than two months to reach a total of $6.6tr.
- Tonight, we expect that Chairman Powell will give a masterclass on central bank navigating in period of crisis. He will explain the why, the what and the how of the latest Fed’s monetary policy tweak. We don’t anticipate any monetary policy change. A rate cut is out of the box – a rate cut while the economy is shutdown would have zero positive impact on aggregate demand. Powell should also rule out negative rates once again, which could be met with strong market disappointment.
- It is unlikely that Powell will provide strong guidance on the path of interest rates or discuss extensively the future of QE or the Fed’s credit support programs, especially the Main Street lending program. It is certainly too early to have details. At best, we believe that Powell could give the market a hint on how the central bank sees the recovery and could allude to a target of unemployment rate as a pre-condition for monetary policy normalization.
- Regarding recent market developments, especially oil prices turning negative, the Fed should downplay risk of outright deflation in the United States and indicates the recent volatility observed in the oil markets is seen as transitory by the committee.
- To sum up, tonight’s press conference is essentially a confidence game during which the Fed will continue to repeat almost every minute its readiness to act as appropriate to offset the current crisis and avoid a market crash, which implies in our view a dovish statement on the Fed ballooning balance sheet.
- You can watch the live press conference from 6:30 p.m. GMT here.
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