Fed Discussed Plans to Provide More Economic Support

Federal Reserve officials began contemplating last month how to provide more monetary stimulus for an economy facing its greatest shock since World War II.

Officials cut interest rates to near zero in March as the coronavirus pandemic deepened, and they affirmed plans in April to hold rates there until they are confident the economy is on track for inflation to reach their 2% target and for unemployment to return to low levels of recent years.

The Fed’s coming discussions for monetary policy are turning on how to signal its plans to keep interest rates low, according to minutes released Wednesday of its April 28-29 policy meeting. One strategy would tie future plans to achieving specific economic outcomes, such as saying the central bank wouldn’t raise rates until inflation reached 2%. Another option would be to provide calendar-based guidance, such as saying the Fed would hold rates low until some date in the future.

A complementary idea discussed last month would reinforce that guidance by purchasing Treasury securities as needed to cap yields on short- and medium-term Treasurys, a policy sometimes called yield-curve control that has been employed by central banks in Japan and Australia.

The minutes indicated officials would begin clarifying over the course of several meetings this summer their intentions about future monetary-policy decisions. Their next scheduled meeting is June 9-10.

Mark Cabana, the head of interest-rate strategy at Bank of America Securities, said announcing caps on short- and medium-term Treasury yields would be an “extraordinarily powerful” way to reinforce any specific guidance about how long the central bank expects rates to stay near zero.

Officials also reviewed the success of large, open-ended purchases of Treasury and mortgage securities they initiated in mid-March to stem major dislocations in those core financial markets. The Fed has reduced those purchases as market functioning has improved. They haven’t said how or when they might shift to the types of bond-buying programs, called quantitative easing, they employed between 2009 and 2014 to provide stimulus rather than improve market function.

The central bank is purchasing $30 billion in Treasurys and $22.5 billion in mortgage securities this week. That is down from a peak during the week of March 23, when it purchased $375 billion in Treasurys and was prepared to buy as much as $250 billion in mortgage bonds.

Some officials said last month that they would want to provide more clarity about how these purchases would unfold.

The U.S. Treasury is set to issue trillions of dollars in additional securities over the next year to finance coronavirus-related spending.

“The big underlying story is the horse race between Treasury issuance and Fed purchases,” said James Sweeney, chief economist at Credit Suisse. If Congress approves another round of economic relief, there could be upward pressure on rates as Treasury issues more debt, and the Fed would want to limit any upturn in rates by increasing its asset purchases, he said.

Mr. Cabana said the market would welcome more specific guidance around Fed asset purchases. “It seems like they have been figuring out how little they need to buy to provide market functioning instead of how much they need to buy to provide adequate monetary stimulus,” he said.

Mr. Cabana said he was concerned the current approach risked a re-run of a market-roiling episode like one that occurred last September in overnight funding markets when officials were slowly draining bank deposits held at the Fed, called reserves, from markets.

“The risk is they buy too little and you see unnecessary Treasury market stress,” Mr. Cabana said.

Fed officials’ discussion highlights the difficulty officials could face in spurring a stronger economic recovery now that interest rates have been cut to near zero. Officials conducted a policy review last year to plan for such a scenario, and Fed Chairman Jerome Powell had been preparing to unveil those findings at the central bank’s June policy meeting until the pandemic brought economic activity to an abrupt halt in March.

The minutes said that review was on track to be completed later this year, and that releasing its conclusions could help further clarify the Fed’s plans.

The minutes revealed officials’ significant alarm over the extent of economic dislocations so far. Some version of the word “severe” appeared in the minutes eight times to describe economic conditions or forecasts, while some version of the word “extraordinary” was used four times.

Fed staff economists laid out a baseline scenario in which restrictions on social interactions would gradually ease, boosting economic growth and reducing unemployment. But in a sign of the extreme uncertainty facing forecasters, they said their more pessimistic projection “was no less plausible than the baseline forecast.”

Officials worried that temporary layoffs could become permanent if there were additional infection waves this year and that a “large number of small businesses” wouldn’t be able to endure a long-lasting shock.

Even after social-distancing restrictions end, some business models “may no longer be economically viable,” officials said, and spending in sectors such as entertainment and travel that demand greater human interaction could remain weak.

While officials saw recently enacted spending measures by Congress and the White House as “crucial for limiting the severity of the downturn,” the minutes said officials believed “even greater fiscal support may be necessary if the economic downturn persists.”

The minutes showed some officials were anxious about greater stress hitting U.S. banks, particularly if the pandemic worsens. “This sector should be monitored carefully,” the minutes said.

Officials said high levels of business debt could exacerbate any stress on the banks in the current downturn, and some believed regulators “should encourage banks to prepare for possible downside scenarios” by limiting capital distributions to shareholders, the minutes said. “Indeed, historical loss models might understate losses in this context, ” they said.

The minutes didn’t show any discussion around policies to cut interest rates below zero, an idea that has been the source of speculation by some investors even though Fed officials have more recently said they have no interest in it.
Source: Dow Jones