At the December 2020 meeting of the Federal Open Market Committee (FOMC), the Fed kept the pace and composition of its asset purchases unchanged, but provided new forward guidance, in line with expectations. According to the Fed statement, the current pace of asset purchases will remain in place until “substantial further progress” has been made toward achieving the Fed’s dual mandate objective. In practice we think this means at a minimum through late 2021.
The Fed has now provided some degree of forward guidance for both of its monetary policy tools – balance sheet and interest rates – completing the transition from crisis management to monetary policy accommodation aimed at supporting the ongoing recovery. While the Fed has spelled out specific metrics it needs to see before it would consider its first policy rate hike since 2018, Wednesday’s balance sheet guidance was left vague. This likely reflects significant uncertainty about the economic recovery and a difference in views among members of the committee about the extent to which additional monetary policy support is needed. However, the absence of more specific guidance on the balance sheet also means market participants will be left searching for clues on what “substantial” progress means over the next several quarters, particularly if the recovery is uneven.
The limited reaction in U.S. Treasury markets to the new FOMC statement suggests the Fed has provided enough clarity – for now. But with the Fed forecasting strong growth, a significant drop in unemployment and a slight pickup in inflation (according to the new December 2020 Summary of Economic Projections, or SEP), the Fed at some point will likely need to provide clearer guidance on the reaction function for asset purchases to avoid miscommunication.
‘Substantial further progress’
Clear forward guidance is the next step in moving from crisis management, where large asset purchases were used to restore market function, to a monetary policy approach where asset purchases are supporting easy credit conditions. However, the guidance in the Fed statement and in Chair Jerome Powell’s press conference did not specify what “substantial further progress” will look like in practice and gave market participants little new information (since the view of ongoing asset purchases was already consensus).