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Fed Sticks To Coronavirus Plan: Zero Rates And QE

The Federal Reserve signaled Wednesday that it will anchor its benchmark interest rate near zero for a year and perhaps much longer. The meeting statement also affirmed the Fed’s stance of unlimited quantitative-easing asset buys. Fed chief Jerome Powell’s press conference did nothing to spoil the mood on Wall Street as the Dow Jones surged to a post-coronavirus-crash high on good news about Gilead’s Covid-19 treatment.

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With the coronavirus shutdown costing the U.S. economy 24 million jobs, the Fed statement noted “a surge in job losses” and “tremendous human and economic hardship” due to the coronavirus crisis. Policymakers said the health crisis will weigh heavily in the near term and “poses considerable risks to the economic outlook over the medium term.”

The Fed said it will keep rates in the 0%-0.25% range until the “economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”

Powell said at his post-meeting press conference that the Fed would continue to act “forcefully proactively and aggressively” to try to assure a robust recovery.

But he indicated that the road would likely be a long one. “It will take some time” to reach “anything that resembles maximum employment,” he said.

Dow Jones, Treasury Yields React To Fed Meeting

The Dow Jones Industrial Average and other major indexes initially came off intraday highs after the Fed meeting, then strengthened, before paring gains slightly at the closeThe Dow Jones climbed 2.2%, the S&P 500 rose 2.7%, and the Nasdaq composite added 3.6%.

Meanwhile, the 10-year Treasury yield, which dipped to 0.6% ahead of the Fed’s 2 p.m. ET statement, ticked up slightly to 0.62%.

Fed Chief Powell: The $6 Trillion Dollar Man?

The Fed didn’t announce major new actions because it’s already committed an unprecedented amount of support to keep the U.S. economy from imploding due to the coronavirus shutdown.

In March, without waiting for its regularly scheduled meeting, the Fed slashed rates close to zero in two steps, launched unlimited quantitative easing and scooped up more than $2.4 trillion in assets, primarily Treasuries and mortgage securities.

The bottom for the Dow Jones and broader stock market came on March 23, the day the Federal Reserve launched unlimited QE. While the $2 trillion federal aid package also played a role in shifting sentiment, “Don’t fight the Fed” has proved to be good advice.

Under Fed chief Powell, the central bank has announced a series of programs that could see it provide $4 trillion in funding to businesses hurt by the coronavirus, as well as states and municipalities. The Cares Act coronavirus rescue set aside $454 billion for the Treasury Department to backstop the programs, with the Fed supplying the bulk of the liquidity.

How Big Will The Fed’s Balance Sheet Get?

Some Wall Street firms expect the Fed balance sheet to keep surging, from $6.6 trillion last week to about $11 trillion in coming months. That will be driven by Fed lending programs and purchases of corporate and municipal bonds.

But there’s a pretty big wild card, says UBS chief economist Seth Carpenter. “Demand for the credit facilities could be less than we think if the terms are not attractive,” he wrote. He sees the Fed balance sheet ending the year at about $8.5 trillion.

Powell gave an update on the lending programs to business. The programs aren’t up and running yet. The big business lending facilities should be ready soon, he said. But it will take a little longer to ready the Main Street Lending Program for small and midsize firms.

Powell noted that the Fed program isn’t limited by a dollar ceiling, like the Small Business Administration’s Paycheck Protection Program that temporarily ran out of funds. However, he did signal some doubt about how much demand there will be.

There’s a “tremendous amount of financing going on” for companies that might have tapped Fed facilities. His view is that the announcement of the Fed programs “got the (credit) market functioning again.”

What’s Next For Fed Quantitative Easing

The Fed restarted quantitative easing with a March 15 announcement, saying it would buy “at least” $700 billion in Treasuries and mortgage securities to assure the smooth functioning of markets. A week later, the Fed said it was all in and would buy “the amounts needed” to get the job done.

At the peak, it took daily purchases of $75 billion in Treasuries and $50 billion in mortgage-backed securities, or $625 billion in a week. But the Fed has gradually dialed back those amounts. This week, it’s buying $10 billion in Treasuries each day and $8 billion in MBS.

The thrust of the Fed’s intervention has shifted to its new credit facilities. But economists are beginning to think about what will happen after those have been tapped.

A key question: What will the Fed do to keep long-term interest rates low as multitrillion-dollar deficits create a flood of issuance?

Yield Curve Control?

Wall Street economists think the answer may be something the Federal Reserve last tried in the 1940s: yield curve control. Many expected at least a preliminary discussion on Wednesday, though not necessarily an announcement.

“When the economy starts to recover with very large federal debt issuance, there is some risk of an unwelcome jump in Treasury yields,” wrote Lewis Alexander, Nomura’s chief U.S. economist. “Ultimately we think the FOMC will adopt some form of yield curve control.” He expects such an announcement by June.

Yield curve control could be a way for the Fed to conserve its balance-sheet ammunition. One way it might work is for the Fed to set interest rates, rather than market forces, up to perhaps two-year Treasuries. While longer-term yields might still float, the Fed could use all of its QE power at the longer end of the Treasury curve to hold rates in check.

But that’s a subject for another day. Fed chief Powell didn’t touch on the possibility on Wednesday.

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