Never underestimate American ingenuity, especially when it comes to the Federal Reserve’s ability to invent monetary policy on the fly.
The U.S. central bank’s top officials, led by Chair Jerome Powell, are expected this week to announce new “qualitative outcome-based” guidance to specify the conditions under which they might taper their stimulus-focused bond purchases, now proceeding at $120 billion a month. Such qualitative guidance would hinge on subjective criteria, such as a promise to keep buying bonds at the current pace until the pandemic is under control – which might be open to interpretation.
Since no changes are expected to the level of benchmark interest rates, already cut to near zero, the guidance might be the most significant outcome from the two-day, closed-door meeting that culminates Wednesday.
The new approach would join a growing list of unprecedented monetary strategies hatched by the Fed since the financial crisis of 2008, from former Chair Ben Bernanke’s “quantitative easing,” known as QE, to the “average inflation targeting” adopted in September. These are considered unconventional policies since they come into play once the Fed can’t cut interest rates any further without pushing into negative territory.
The upshot is that Fed officials might be using the new guidance as a way to tamp down expectations the bond purchases would continue ad infinitum, while leaving ample flexibility to continue the program as long as they see fit.
“The most important innovation for this meeting is likely to be an enhancement to their QE guidance by adopting qualitative outcome-based language,” Deutsche Bank Chief U.S. Economist Matthew Luzzetti told clients last week in a report.
The Fed meeting is likely to be closely tracked in cryptocurrency markets, where bitcoin has been cast by investors from both digital-asset markets and traditional finance as a potential hedge against central-bank money printing and inflation. Bitcoin prices have shot up 170% this year as the U.S. central bank expanded its total assets by more than $3 trillion to $7.3 trillion.
Risk of a new 'taper tantrum?'
With the coronavirus still taking a devastating toll on the economy, there’s little expectation that officials would move anytime soon to end the ongoing bond purchases, which are designed to provide stimulus to the economy by keeping monetary conditions ultra loose.
And, in fact, according to Michael Feroli, chief U.S. economist for JPMorgan Chase, the Fed officials might even move at this week’s meeting to ease conditions further by extending the average maturity of the bonds it purchases. Such a move would theoretically put downward market pressure on long-term interest rates that tend to be the highest, making it cheaper for businesses and households to take out loans.
But Feroli noted the contrast between the new “qualitative” guidance and “quantitative” policies that might be tied to hard numerical metrics like inflation or unemployment goals.
“It could be as simple as noting that purchases would taper and cease before the first rate hike, though all this would say is they expect to cease purchases sometime before 2024, which isn’t very informative,” Feroli wrote. “A reasonable evolution of the statement language would predicate purchases on the course of the public health crisis.”
One “risk,” according to Feroli, is that traders start speculating on the timeline for broad distribution of a vaccine and perhaps then conclude bond purchases might wrap up sooner than most investors are currently anticipating.
“This sets up the risk that new guidance could spark another taper tantrum,” Feroli wrote, referring to the moment in May 2013 when bonds sold off on fear the Fed was going to taper its bond purchasing program. “A possible safeguard would be to pledge to purchase assets until ‘well after’ the public health crisis passes, or some similar wording.”
According to economists at Bank of America, the second-biggest U.S. lender after JPMorgan, thresholds for tapering the bond purchases might be “open to interpretation, however, which provides flexibility but also potentially some discomfort for market participants.”
“The Fed wants to make sure that asset purchases keep interest rates low enough and financial conditions supportive enough to help drive economic growth and deliver higher inflation,” according to the report.
Qualitatively speaking, the Fed usually gets what it wants.