Today’s Federal Open Market Committee (FOMC) meeting in some way represents a big step towards normality for investors, as they await what the Fed will do next having returned to its scheduled programme of meetings. So what can we expect from the Fed today?
From our perspective the ‘shock and awe’ is behind us, and now the Fed has to contend with the reality of a very heavy Treasury funding programme combined with zero interest rates and an economy in deep recession.
The first problem is who is going to buy all these US Treasuries while the yields are so low. We have argued before that at these levels, US Treasuries will not give investors the same protection they did in the past when yields were higher. They remain risk-free, but while yields are this low we would also regard them as return-free. Many investors will be happy to own them for liquidity purposes, but a fear of rising yields will draw them towards owning shorter dated USTs, where the price risks associated with rising yields are lower. The Fed will therefore need to own more bonds going forward, as supply weighs on a market that to us is quite frankly unattractive at the longer end of the yield curve.
So policy number one is an ongoing formal quantitative easing (QE) programme. In the event that this is deemed not enough, and yields in longer dated securities do start to drift higher (and to a point that the Fed sees yields as a hindrance to the recovery) then we would expect a policy of yield curve control to be enforced. We think it is too early for this at the moment; for investors banking on yield curve control, some further pain on Treasury prices is required first, so timing is crucial for this one.
The second policy we expect to see today is forward guidance. Given the unprecedented actions taken by the Fed, the question for investors is how long these policies will last, how long rates will be at zero and how the Fed wants the yield curve to look. Forward guidance in this context is very useful from a fixed income perspective, but also very useful for businesses and the wider economy, as they should be able to invest with confidence in cheap borrowing for a period of time, and term out their financing at very cheap levels.
These would be two very useful additions from the Fed, but at this stage this is all we would expect from Powell and co. The comments on the economy will also be very interesting, so Wednesday’s meeting is a must-watch.