Fed Relies on Forward Guidance – Keeps a “Wait and See” Message

The Federal Reserve convened this week for its last meeting in 2020. The Fed didn’t make any significant changes to its policy and provided accommodating forward guidance and some clarity on its asset purchase program.

The Fed expects to purchase 80 billion worth of bonds and 40 billion of MRS a month for as long as needed. I’m sure that Fed Chair Powell knows well how markets could get jittery if and when the Fed signals its plans to taper QE – or he can always give a call to Bernanke to retell the 2013 Taper Tantrum episode. For now, the Fed remains accommodating and doesn’t plan to taper its QE program anytime soon. And we won’t hear any talks of QE tapering until the Pandemic is under control – so probably not before the second half of next year.

In this meeting, the FOMC also release a revised outlook for key economic figures. FOMC members raised their GDP projections and lowered unemployment and inflation targets – providing a more bullish outlook. Considering they didn’t change the guidance for interest rates, this offers a dovish signal for the markets. The market reaction was subdued as stocks edged up and long-term treasury yields remained flat.

At this point, the Fed is in a “wait and see” mode as it waits for the Congress stimulus bill’s outcome and see if the economic slowdown that has started in recent weeks will escalate to a financial crisis that will require its intervention. Specifically, some economic reports were disappointing: The jobs report missed expectation; November’s retail sales dropped by 1.1% – the first month-over-month fall since April – and jobless claims reached their highest weekly figures since October. The K shape recovery that is metalizing concerns Fed members and may keep them more cautious on turning hawkish even if inflation were to rise by the second half of 2021.    

Bottom line

The Fed continues to rely on forward guidance to do the heavy lifting because, as Chair Powell explained in the press conference, the Fed’s policy works in a lag. Since most of the recovery’s uncertainty revolves around short-term risk – especially related to the Pandemic’s progress and whether Congress would provide fiscal support to the economy – the Fed prefers to remain on the sidelines until the markets warrant further stimulus.

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