One thing is clear that the Fed will not provide greater clarity regarding the likely trajectory of target federal funds rate for the time being. That may be feasible sometime in the future, but for now that may not be possible. That is clear from the probabilities assigned to a rate cut in Fed Fund Futures trading as per CME Fedwatch.
|Probability||16 Sep FOMC||05 Nov FOMC||16 Dec FOMC||27 Jan FOMC||17 Mar FOMC|
|Probability of Fed rate staying at 0.00%-0.25%||100%||100%||100%||100%||100%|
Key takeaways from the FOMC minutes for Jul-20 meet
Here are some of the key takeaways from the minutes of the July Fed meet published on August 19.
• No indication or forward guidance likely on rates trajectory. FOMC has virtually committed to hold rates near zero till specific thresholds for inflation and unemployment are achieved.
• The real challenge for the Fed in the last few months has been too little inflation and not too much inflation. The chart below explains the point quite clearly.
• Clearly, the Coronavirus Pandemic is holding back growth and that is holding back inflation. Hence, the Fed has almost ruled out any fresh guidance on rates till inflation comes closer to the red line above. That means, near-zero rates in the US are here to stay for the foreseeable future.
• Members of the FOMC were unanimous that the public health crisis and rising cases in the US weighed heavily on GDP, employment and inflation in the near term. This had largely clouded the medium term outlook for the US economy with larger implications for the world economy too.
• There was near unanimity on the urgent need to continue to buy treasury and mortgage-backed bonds at a pace of $120 billion a month. This would expand the Fed balance sheet substantially, but clearly the Fed cannot risk short liquidity becoming an impediment to long term economic growth.
• In an interesting set of observations, the FOMC identified risk factors like new waves of virus outbreak, weak credit growth, waning fiscal support and risk of weak global growthin emerging markets. The pandemic is expected to result in restructured businesses, slowingGDP growth and US productive capacity.
• The Fed strategy clearly seems to be to wait for inflation and unemployment to reach desired levels before taking a re-look at the interest trajectory. Rate hikes are ruled out in the foreseeable future. Instead, asset purchases may be sharpened to give the markets the comfort of liquidity.
• One interpretation of the FOMC language could be that it may adopt a more relaxed approach to inflation; allowing inflation to even exceed 2% at times just in order to ensure that reviving economic growth is paramount.
• This brings us back to Jerome Powell’s famous statement in the FOMC meet in July, “The central bank is not even thinking about thinking about raising rates.” The minutes of the meet underlined that there had been an increase in uncertainty about the economic outlook and that matters a lot for key players in the US economy.
• The Fed minutes also pointed to the dichotomy paradox in the US labour market. Blue collar workers appear to have frozen and businesses were having trouble finding workersdespite jobless ratesof 10%.
• The minutes also discussed about Yield Curve Control (YCC) or Yield Caps wherein Fed puts a cap on interest rates. However, the idea was not received too enthusiastically as officials only saw modest benefits at a time when yields were already abysmally low.
India has reasons to be pleased with the Fed minutes
India surely would have reasons to be pleased with the minutes for multiple reasons. Firstly, it gives a solid ground for the RBI to continue with its accommodative stance with respect to rates. Secondly, like the US Fed, the RBI is also likely to adopt a policy of rates trajectory being driven by weak growth rather than by high inflation. Thirdly, the $120 billion monthly liquidity infusion is a signal that global markets will remain well supplied. That is good for liquidity-hungry markets like India.
The US Fed, in the year 2012, had adopted the policy of pegging interest rates trajectory to inflation. The time has probably come for the Fed to rethink the strategy and peg it to growth instead of inflation. Powell and team have been working on an alternative model for nearly 2 years and the outcome will be of interest to India too.