Fed sends asset purchasing back on the field

Despite another rate cut yesterday, the Federal Reserve signaled future action will be data dependent. But while it might stay on the sidelines in terms of rates, it has returned to the field to adjust its level of reserves.

As expected, the Federal Open Market Committee (FOMC) lowered the fed funds target range by 25 basis points, to 3.50-3.75%. In his press conference, Chair Jerome Powell said this put monetary policy as “plausibly neutral.” The language in the statement was tweaked slightly but meaningfully for those who dissect FedSpeak. In particular, the FOMC added “extent and timing of” to a sentence discussing the potential for additional policy adjustments. The last time the Fed qualified the path forward in this manner was last December, when the Fed pivoted to a wait and see approach that lasted nine months. The big question is whether we will see a similar result.

The meeting was the most contested one in a long time, with three dissents: Governor Stephen Miran preferred a 50 basis-point reduction while Kansas City Fed President Jeffrey Schmid and Chicago Fed President Austan Goolsbee did not want to make any move. The new Summary of Economic Projections’ (SEP) “dot plot” reflected the disagreement with a wide dispersion. Out of 19 total FOMC participants, only 12 dots were in line with the outcome and six preferred no action, with the other being Miran. Powell described the discussion as “good” and “respectful,” saying that the differing views reflected the balance of risks. It was probably more of a spirited debate.

As was the case in September, the SEP forecasted 25 basis points of easing in each of the next two years, with a terminal range for this cycle between 3-3.25% and a long run policy rate of 3%. The unchanged nature of the dot plot is consistent with the Fed not having seen reliable economic data over the interim period to change their views.

In Powell’s remarks on the softness in the labor market, he acknowledged the Fed has concluded that the federal government has been systemically reporting more added jobs that are the case — overstating gains by as much as 60,000 per month. If true, that would mean payrolls have actually declined recently. That said, Powell maintained that the 75 basis points of rate cuts over the past three FOMC meetings should provide support to the labor market. The Fed’s latest SEP reflected more optimism on growth and a slight decline in inflation.

Despite Powell’s focus on employment, we believe that the Fed will maintain the current fed funds range until data indicates otherwise. It has been working with less-than-optimal economic data because of the shutdown but is due to get a big chunk of data next week, including CPI and the employment report for November, though that information may be a bit distorted due to the shutdown. Of course, the change in leadership when Powell departs could change our opinion.

$40 billion insurance policy

The extent to which the reduction of the Fed’s balance sheet is causing funding pressures in the repo market has been a concern for us and the markets lately. The Fed addressed that by announcing plans to buy $40 billion of Treasury bills per month, starting tomorrow (December 12). We anticipated that the Fed could take some steps, but the timing and magnitude went beyond our expectations. Powell characterized part of the figure as stabilizing reserve supply — the $20 to $25 billion estimate we expected — with the sudden start presumably to mitigate a potential spike in repo rates heading into year-end. But the remaining amount is meant to offset a seasonal decline in reserves related to tax payments. In fact, the Fed intends to continue at a similar pace until potentially slowing after the April tax date.

With $6.7 trillion in Treasury bills outstanding, we are not in danger of running out of supply. But the incremental purchases, averaging about $10 billion a week, likely will lower front end yields for bills and repo rates perhaps by five basis points. We will know more once purchases get underway.