At this week’s meeting, US central bankers are widely expected to approve language specifying that the $120bn per month in debt purchases launched at the start of the pandemic will continue until the recovery meets certain conditions, according to senior economists and Fed watchers.
At the moment, the Fed says its bond purchases will continue at their “current pace” only over the “coming months” — a far more limited timeframe.
If agreed, the change would make it harder for the central bank to make an early move to wind down its bond purchases, cementing its easy monetary policy for years to come. The shift would complement its pledge to keep interest rates close to zero until inflation is on track to exceed 2 per cent and the economy reaches full employment.
In addition, the Federal Open Market Committee will be forced to consider whether bolder monetary easing through the asset-purchase programme is warranted.
With Covid-19 cases rising, lay-offs rising and confusion on Capitol Hill about the prospects for fiscal stimulus, some economists say the Fed may have to act now to meet its pledge to do more to support the recovery if needed. Last week, the European Central Bank increased the size of its bond purchases and extended their duration after the eurozone economy was hit with more infections and restrictions.
“We have a worse virus, more shutdowns and more evidence it’s spilling over into hiring. Meanwhile, fiscal policy is way up in the air — we have no idea what we’re going to get,” said Julia Coronado, an economist at Macropolicy Perspectives. “I just don’t think it makes sense to come to the table with nothing in your hands.”
If the Fed decides to take more aggressive monetary action, the most likely possibility would be to shift the maturity of its debt purchases towards longer-dated bonds. Purchases so far have so far been slightly weighted towards the shorter end.
A far less likely option would be an increase in the overall value of the debt purchases, which currently amount to $80bn of Treasury debt and $40bn of agency mortgage-backed securities per month.
Fed officials have been cautious about taking such extra steps. Last month, they said the asset purchase scheme as currently designed was effective and they would only move to boost it if the economic situation changed.
Roberto Perli, an economist at Cornerstone Macro, said there were a “number of reasons” for the Fed to take stronger easing action, including the need to offset the growing pandemic risks and its own desire to stoke higher inflation. But he was not sure the Fed would follow through, given that “we haven’t heard anything” setting it up from senior central bankers.
“It’s the right thing to do and I wouldn’t be surprised if they do it, but it’s hard to make a forceful call,” Mr Perli said.
Some investors believe the Fed can afford to hold off on taking any strong action on Wednesday, in light of the fact that financial conditions have eased to levels seen before the coronavirus crisis. US stocks have climbed to fresh all-time highs in recent weeks, and borrowing costs for corporate America and homebuyers still hover at historic lows.
According to Anders Persson, chief investment officer of global fixed income at Nuveen, this positive market backdrop is likely to take the pressure off the Fed to do anything beyond changing its guidance.
“They will save that chip for another time,” added Leslie Falconio, senior fixed-income strategist at UBS Global Wealth Management.
Strategists at Morgan Stanley said they did not see a need for the Fed to make substantive adjustments to its asset purchase programme, but stressed that the changes to the guidance would have an impact.
“The language will replace the ‘over coming months’ guidance and offer the Fed more flexibility on the timing of tapering as the economic outlook evolves,” a team led by economist Ellen Zentner wrote in a recent note. They added that the tapering of asset purchases could begin as early as the first half of 2022, with no interest hikes expected until 2023.
Congress could help tip the balance towards more action, however, especially if no new fiscal stimulus plan is agreed soon.
“The less action on the fiscal front, the more inevitable it is that the Fed looks to do something at the next meeting,” said Nick Maroutsos, head of global bonds at Janus Henderson. “They’ve given off this impression that they are there to support markets. That is not going to go away anytime soon.”