The outbreak of the Covid-19 pandemic sent shockwaves through the American economy in the first quarter of this year, and the Fed sprung to action to save the economy from a severe collapse by delivering an emergency rate cut that saw the Fed funds rate settle close to zero. On top of this historic rate cut, the Fed decided to resume asset purchasing in a bid to increase bond prices and cut down yields, which is a commonly used strategy by central banks around the world to keep interest rates low to accelerate credit growth. A closer evaluation of the U.S. economy and the recent remarks by Fed Chair Jerome Powell give reason to believe that the Fed will continue to purchase treasuries at least through the end of 2021.
The Fed has taken unprecedented measures to help the U.S. economy
Policymakers were accused during the financial crisis of 2008 of not being proactive in helping the U.S. economy. This time around, however, the Fed has gone over and beyond investor expectations to save the economy from a historic collapse. As the below chart confirms, the balance sheet of the Fed has expanded at a never-before-seen pace in 2020.
Fed balance sheet
Source: Federal Reserve
The Fed carried out its quantitative easing (QE) measures in 3 phases following the global financial crisis, and the third phase in which the Fed purchased $85 billion worth of treasuries per month was widely believed to be the largest asset-buying program by the policymaker. To fight the economic challenges presented by the Covid-19 pandemic, the Fed launched a program to buy $120 billion in bonds a month, including $80 billion in treasury securities and $40 billion in mortgage-backed securities. This program, therefore, will go down in the history books as the largest asset purchase plan introduced by the Fed to help revive economic activities in the country.
Speaking to the media earlier in the month, Fed Chair Jerome Powell said:
“This is a big program and it’s doing a lot of good. We don’t expect that things will deteriorate, but nonetheless, we have a habit of keeping things in place for a while.”
The dot plot released by the Fed in September confirms there is no plan whatsoever to hike rates in 2021 and 2022.
Source: Federal Reserve
Even though the dot plot should not be taken as a guarantee of future monetary policy decisions, it’s reasonable to assume that a drastic change is unlikely to occur given the dire state of the American economy.
On Nov. 9, Pfizer Inc. (PFE) announced preliminary efficacy data for its Covid-19 vaccine candidate BNT162b2 which indicated a 90% success rate among infected patients. This is good news for the economy, but the long-term outlook for the Fed’s asset purchasing program will not be materially amended based on such data. For this to happen, the American economy should stage a comeback and inflation should head closer to the 2% target rate mandated by the policymakers, which is unlikely to happen because of a few reasons. First, oil prices are still struggling to recover and there is an inventory pile-up that needs to be accounted for as well. Second, airlines and cruise operators are setting themselves up to provide consumers with massive discounts to lure them into travel and leisure activities once the world returns to its normal state. Third, physical retailers can be expected to provide similar discounts once business conditions improve. Demand-pull inflation or cost-push inflation, therefore, is unlikely to materialize in the foreseeable future. For the economy to truly recover, the government might have to step in and introduce another stimulus package as the Fed has already done what it takes to revive the economy.
About the author(s)
Harold Alby is a managing director and chief operating officer at Inova Capital. Justin Inniss is a managing director at Inova Capital.For more details on our insights please get in touch with us at Inova Capital AG on +41 415616905. Inquire about our ideas and nowcasting capabilities.