The Federal Reserve on Wednesday released the minutes from its June meeting. This included an important discussion around forward guidance as well as some clues about what the Fed's goals are behind some of its policy actions. Separately, last week the Fed released the first detailed report on what individual corporate bonds it has bought so far. Here are my takeaways from both of these releases.
The headline grabber from this meeting will probably be the discussion around yield-curve control, or YCC. Chair Jerome Powell fanned the flames that YCC was coming when he gave an extended discussion on it at the post-meeting press conference in June. But based on the minutes, it seems that "nearly all participants indicated that they had many questions regarding the costs and benefits of such an approach."
That certainly doesn't sound like a program that is about to be implemented.
In context, I think the hangup comes from two spots. The first is that rates are already low, how much more benefit are we actually going to get from YCC? The second is how YCC, especially if it were focused on longer-term bonds, could be more distortive on market functioning than they want it to be. I still think YCC is a good way of communicating forward guidance, and my reasons are summed up by this comment from the minutes related to yield-cap targets, or YCT.
"A couple of participants remarked that an appropriately designed YCT policy that focused on the short-to-medium part of the yield curve could serve as a powerful commitment device for the Committee. These participants noted that, even if market participants currently expect the federal funds rate to remain at its ELB through the medium term, the introduction of an effective YCT policy could help prevent those expectations from changing prematurely -- as happened during the previous recovery..."
With or without YCC, some kind of communication about the Fed's plans for QE and short-term interest rates is coming. "Most" thought such a communication would be helpful, and a "number" thought clear forward guidance made policy more effective. A number of ideas were tossed out for how to make these communications, but it seems the most popular was to pledge to keep interest rates very low and quantitative easing going until inflation hits some target. This might be accompanied by a statement that a short-term overshoot would be tolerated.
This is a crucial point for investors to understand. It means general interest rates aren't going to rise until inflation accelerates. So even if the economy rebounds nicely from here, don't expect the Fed to hike rates until inflation is a problem.
But Otherwise the Fed Looks Pretty Negative on the Economy
The Fed sees a catch-22 for the economy. We need to get things reopened to get it moving again, but reopening makes the continued outbreak of Covid-19 more likely. In the weeks since June 10, the dramatic increase in cases in Florida, Texas, Arizona and elsewhere was exactly what the Fed was talking about.
In turn, that means the Fed is going to have to keep policy accommodating all the longer, as "participants judged there to be a great deal of uncertainty and expressed concerns about the possibility that an early reopening would contribute to a significant increase of infections. Participants also regarded highly accommodating monetary policy and sustained support from fiscal policy as likely to be needed to facilitate a durable recovery in labor market conditions."
Little Talk of Corporate Bond Buying
Despite getting so much attention from traders and the financial media, the Fed hardly talked about the corporate bond program at this meeting. Nor did he discuss muck of the municipal lending facility. The Fed basically claimed "mission accomplished" on financial market functioning.
"Regarding developments in financial markets, participants agreed that ongoing actions by the Federal Reserve ... had helped ease strains in some financial markets and supported the flow of credit to households, businesses, and communities. Measures of market functioning in the markets for Treasury securities and agency MBS (mortgage-backed securities) had improved substantially since March. Strains in short-term funding markets had receded as well, and the volume of borrowing at many of the Federal Reserve's liquidity facilities had moved lower as borrowers returned to market sources of funding. Risk spreads across a range of fixed-income markets had narrowed as the intense flight to safety witnessed in financial markets in the spring ebbed further."
This program isn't anywhere near as important to the Fed as it is to the media.
Lessons of the Fed's Individual Corporate Bond Buys?
Last week the Fed disclosed the specific corporate bond issuers they bought as part of their Secondary Market Corporate Credit Facility. I was surprised how many people were surprised by the kinds of names they bought. The Top 5 were all some of the largest corporate bond issuers (AT&T (T) , United Health (UNH) , Walmart (WMT) , CVS (CVS) and Boeing (BA) ), to logically those would be larger purchases for them. I'm not sure what some people were expecting, but this is exactly in keeping with what the Fed said it would do.
Remember that their purpose isn't to "help out" or definitely not "bail out" any of these companies. At this point, the credit markets are functioning fine. The Fed doesn't need to intervene. It is only following-through with these purchases because it wants to stay true to its word.
By buying very small lots of a large number of issuers, the Fed will wind up having a very small impact on the market stemming from the direct buying. The impact on any given issuer will be almost zero. Right now, it only has holdings of 44 different issuers, but I suspect that will be more like 300 before this program is done. The announcement of this program was critical, but unless something changes dramatically, the ongoing operations of the program are near meaningless.