MNI PREVIEW: Fed to Hold Rate Near Zero and Debate Guidance

By Jean Yung

     WASHINGTON (MNI) - The Fed is set to look at bolstering forward guidance at

this week's meeting and take stock of emergency programs announced in recent

weeks aimed at bringing the economy through the coronavirus pandemic. 

     Plans to pump trillions of dollars into financial markets have aided

trading and curbed spikes in volatility since the coronavirus hit the U.S.

economy. Slashing benchmark rates to around zero and promising open-ended

purchases of Treasuries also helped maintain demand, key to the eventual

recovery. 

     Yet half the announced loan facilities have yet to start operations,

including the corporate bond purchase program and the high profile Main Street

Lending Program to support medium-sized businesses. Banks and former Fed

officials told MNI that take-up on the Main Street program may fall short unless

certain terms are revised. 

     Analysts do not expect substantial moves on monetary policy at this

meeting, though some former Fed officials told MNI earlier-than-expected action

to strengthen forward guidance would be helpful to the recovery in the long run.

     The Fed is set to downgrade its assessment of the U.S. economy, with more

than 26 million initial unemployment claims filed over the past five weeks and

record-setting declines in retail sales, business investment and consumer

sentiment. Some top Fed officials have cited the potential for the economy to

start turning around in the third quarter.

     --FORWARD GUIDANCE

     But officials are likely to tread cautiously on making many specific

predictions about the outlook. The Fed declined to publish forecasts at its last

meeting and is not due to put out fresh ones until June. At some point, the

FOMC's previous forecast of 2% growth this year may turn into something like the

IMF's more recent estimate of a 5.9% contraction.

     The FOMC will debate how much further to go with its forward guidance,

building on its March 15 commitment to maintain the fed funds rate near zero

"until it is confident that the economy has weathered recent events." 

     Policymakers could surprise markets by beefing up the language or go as far

as setting targets for unemployment and inflation or more specific timing,

former Fed officials told MNI. Officials could also commit to deploying the full

extent of its policy arsenal like bond buys and credit facilities until the

economy has fully healed from the coronavirus pandemic. 

     --QE AND YIELD CAPS

     Forward guidance could be buttressed by caps on short-term bond yields

later in the year, though officials remain wary of the policy at least in the

near term. 

     The current shape of the yield curve and spreads between maturities are not

contributing to suppress economic activity, former Atlanta Fed President Dennis

Lockhart noted recently. Some policymakers are also apprehensive about making a

commitment which, if they fail to meet it, would risk serious damage to Fed

credibility.

     More broadly, the FOMC has to decide how quickly to taper its bond

purchases as market liquidity continues to improve. It is on track to purchase

more than USD2 trillion in Treasury securities in the first half of the year,

roughly 25% of the market, Wells Fargo analysts estimate. 

     --IOER HIKE

     The Fed could raise its interest on excess reserves and possibly the

reverse repo rate by 5 bps to ensure the fed funds rate is trading well within

its target range. The effective FFR has been trading at 0.05% in April, while

other money market rates such as SOFR has been settling at just 0.01% for the

better part of the past month. 

     The Fed has adjusted IOER in the past when the effective fed funds rate

came within 5 bps of the top or bottom of the range, but the challenge will be

to reassure markets the moves are technical and not part of any premature

monetary tightening.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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