FOMC Meets Tue; With Leveraged Economy Desperately Needing Low Rates, Fed Cornered

The FOMC meets this week. The Fed already has unlimited QE in place. Not much is expected to come out of this meeting. If anything, aware that low rates are needed, Mr. Powell may drop a hint or two that they are ready to do more if the need be.

(Click on image to enlarge)

A two-day FOMC meeting begins tomorrow. This is the last meeting of 2020 and ends with a press conference by Chair Jerome Powell on Wednesday. Nothing market-moving is expected.

As things stand, both short and long rates are under the Fed’s beck and call. Traditionally, the central bank controls the short end of the yield curve, while the long end is determined by market forces. But because of quantitative easing (QE), they significantly influence – if not control 100 percent – the long end as well. Both the fed funds rate and the 10-year treasury yield remain very accommodative (Chart 1).

The benchmark rate is currently between zero and 25 basis points, while the 10-year yield (0.89 percent) has been under one percent since March.

(Click on image to enlarge)

The ultra-accommodative monetary policy comes at a cost. During the financial crisis more than a decade ago, the Fed aggressively expanded its balance sheet. After three iterations of QE, it ballooned to $4.52 trillion by early 2015. By August last year, it contracted to $3.76 trillion, before a new round of expansion began.

After that bottom, the violet line in Chart 2 began trending higher until March this year when it went vertical. That was when the Fed announced unlimited QE and aggressively began buying up assets in order to help an economy that was seriously disrupted by Covid-19. The balance sheet was growing with such ferocity that in one single week in early April it expanded by $1.8 trillion.

By early June, the Fed had accumulated $7.17 trillion in assets, before coming under slight pressure over the next one month. After that brief pause, the trend reasserted itself. Last week, the balance sheet hit $7.24 trillion – merely $422 million from a new high reached three weeks go.

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