One-point agenda for the Fed in Dec-20
In the December meet, there was not much left to vote on rates, which were at the lowest possible level of 0.00% to 0.25% range. From this point, the Fed would have to decide either to take Fed rates into negative territory or push the rates higher.
In the detailed outlook published in September 2020, Fed had outlined that rate hikes were ruled out unless the US economy showed genuine signs of a turnaround in growth. Traditional triggers of Fed rates like inflation and unemployment would be subservient to growth and consumption. Effectively, rate hikes were ruled out for now.
Fed has already clarified that, as a matter of policy, it would not move rates below 0% and so rates are already at the lowest possible level. Hence the only item left on the agenda for the members of the FOMC to vote on was the extent and pace of the bond purchase program to infuse liquidity into financial markets.
Minutes of the December 2020 FOMC Meet
Here are the key takeaways from the minutes published on 06 January 2021.
1) The Fed had announced after the Dec-20 FOMC meet that the bond buying program would be sustained at the current rate of $120 billion per month. It now emanates from the Fed minutes that the officials of the Federal Reserve had unanimously backed holding the pace of asset purchases, although some members did suggest the possibility of adjustments in the future.
2) There was a subtle shift in terms of the maturity of the bonds purchases. For example, it was unanimously decided to maintain the pace and composition of bond purchases at the current rate of $120 billion. However, at least 2 members of the Fed even favoured shifting to longer term treasuries, which showed a deeper commitment by the Fed to keep liquidity comfortable and accommodative.
3) One issue that became a hot topic of discussion in the FOMC was that the Fed balance sheet had expanded 75% since March 2020. This has goaded some participants to ask the FOMC to consider future adjustments if required. The chart below captures the pace of the balance sheet expansion by the US Fed and says it all.
4) While there appeared to be enthusiasm on continuing the accommodation, there was hardly any thinking on when the tapering would commence or should commence. FOMC member Loretta Mester went to the extent of sticking her neck out and predicting that any reduction in the asset buying program was unlikely until 2022.
5) The market reaction appears to be that there may not be any effort at slowing down the pace of the bond buying program unless the first signals of the success of mass vaccination program becomes evident. That could improve the growth outlook of the US economy and trigger a change in the growth outlook.
6) Some members of the Fed feel that the tapering could start much later as in the case of the global financial crisis (GFC), when the first signals of tapering only came in 2013. Even then, the US Fed only put a halt on fresh purchases but renewals of existing bond purchases continued. Members of FOMC feel that a similar situation could repeat in the US from 2023 or 2024 onwards.
7) Finally, the outlook of the FOMC members on inflation is quite interesting and split. While some members expect inflation to pick up next year, other members still believe that inflation could stay much below 2% due to a combination of technology driven efficiencies and corporate spending cuts. However, there was unanimity that inflation was unlikely to be significantly higher than 2% even well into 2024.
Fed view could change substantially based on vaccine drive
The US and large swathes of the world embark on one of the biggest inoculation drives in history. Most members have acknowledged that the success or otherwise of the vaccine in curbing the pandemic and re-igniting growth would be the big factor in their outlook for rates, inflation and the bond buying program.
For emerging markets like India, the message is fairly clear. The wordings of the Fed actually betray a high degree of uncertainty about the role of the vaccine. If the vaccine drive is successful and growth and inflation pick up, then the Fed may surprise with a taper sooner than expected. That would tighten the liquidity taps for markets like India.
If the vaccine drive underperforms, it raises fundamental question of growth and economic recovery. Either ways, Indian markets are at historic highs and this is a two-way risk that markets need to acknowledge. That is what we must read between the lines of the Fed minutes.