Morgan Stanley: The Fed - Playing a Strong Hand but Unwilling to Show Their Cards

Jim Caron, Managing Director Global Fixed Income Team
 

Key take-aways from Fed Policy Statement & Presser

• This is critical and the Fed mentioned it would use its “full range of tools” to ensure this.

• Financial conditions. The Fed views the success of their actions through the lens of Financial Conditions. Again, their full range of tools will be used to push financial conditions easier.

•         Remember: financial conditions is an index comprised of short rates, intermediate term rates (T 5-10y), BBB credit spreads, equities, trade weighted value of the US dollar. Easier implies low rates, tighter credit spreads, higher equities and a weaker USD.

• No forward guidance on rates. This was a disappointment relative to what the market was expecting. All the Fed conceded was that “policy levels are appropriate for now”. Many think the Fed will keep rates low until end of 2022, but nothing specific was mentioned. The Fed just said it “will not be in any hurry to hike rates and they will wait until the economy was well on its way to recovery”.

• Fed is not out of ammo. Fed Chair Powell said the Fed is willing to expand the size scope of their market support facilities if necessary.

• Inflation. The Fed sees neither a risk to inflation or deflation. They maintain policy actions to reach their stated 2% inflation targeted.

As we see it: The Fed mentioned several times the need to keep credit flowing to the economy, both for businesses and individuals. This is clearly an important goal for them. They do see a risk that the effects of the pandemic could be longer lasting and credit could become further stressed. In which case, the Fed is willing to expand its market support facilities. But for now, according to the Fed, it is premature to make this or any other economic forecast, take further actions or provide forward guidance on how long policy rates will remain low.

This said, we do not believe the Fed has done enough with respect to consumer credit relative to their strong statements about keeping credit flowing to the real economy. So far, most of the actions have been targeted toward supporting credit in the business sector. Perhaps the Payroll Protection Program is buying them time by supporting the consumer. Eventually these programs end and consumer credit may become targeted for policy support.

Effectively, the Fed’s communication today could be summed up as indicating they are playing a strong hand but unwilling to show all their cards.
 

 

RISK CONSIDERATIONS

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