The Federal Open Market Committee announcement commits it to buying at least $120 billion of securities a month until “substantial further progress” is made on its dual mandate of stable prices and maximum employment, suggesting it will continue well into 2022.
But market watchers warn this doesn’t account for inflation surprises.
The announcement the Fed will continue to buy at least $80 billion of Treasuries and $40 billion of mortgage-backeds each month “is not exactly a surprise but makes the strategy explicit and in line with guidance for the front end,” said Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle, who said the Fed would likely raise rates before tapering the asset purchases.
“The long end of the Treasury curve is pricing-out some expectations of a maturity extension today,” he noted. Primary dealers projected a 2022 taper. “If the Fed's forecasts are taken at face value (they probably should not be), today's announcement commits the Fed to continuing purchases well into 2022. The risk is that we see material inflation surprises ahead of schedule.”
With rates staying low and bond buying continuing, Bryce Doty, senior vice president and senior portfolio manager at Sit Fixed Income Advisors, LLC, said, “The investment strategy will continue to be to take advantage of steady positive revisions as to when vaccines will be approved, to the supply of vaccines available and the how swiftly they can be distributed.”
But he warned, “Be weary of a steeper yield curve and watch for TIPs to outperform traditional Treasuries as inflation will surge after a temporary stall due to recent lockdowns.”
Rose Maguire, senior vice president at Bank Leumi USA, said, "The bond market initially was disappointed with the statement and the longer end of the curve sold off almost 3⁄4 of a point only to recover and end up unchanged" on the day. While a change in purchases or an extension of maturities did not materialize, she said, "the bond market recovered as participants digested the change in language about [quantitative easing] itself."
Since the dot plot suggests near zero rates through 2023, she asks, "does this mean the Fed is saying QE for at least the next three years? That’s how I read it."
If that remains the case, she continued, "with market participants struggling to find not only yield, but struggling to find any bonds at all with the Fed being the 800 pound gorilla in the room buying everything in its reach, where are people going to put money to work?"
The Fed statement might have disappointed “those bulls who had hoped for a change in the size or composition of Fed bond purchases,” said Bruce Monrad, chairman and portfolio manager at Northeast Investors Trust.
And while the statement mention downside economic risks, “its economic projections were marked higher and [Fed Chair Jerome] Powell made mention of the positive impact of vaccines,” he added. “As expected, Powell felt comfortable during the press conference in crossing out of the Fed’s normal lane and urging fiscal stimulus.”
And while the panel sees “the rise in inflation break-evens,” Monrad said, it “chose not to muddy the message by dwelling on the implications.”
Nominal rate gains have been attributed to the rise in inflation expectations, he said, while “real interest rates have barely budged.”
Christian Scherrmann, U.S. Economist at DWS Group, said, “The Fed is in reactive mode, waiting to see how negotiations play out on the Hill while standing ready to react should financial conditions deteriorate.”
By switching its commitment to continue asset purchases from “the coming months” to until it sees “substantial” progress, “this is a material shift in forward guidance, albeit well-flagged in the November minutes,” said Fitch Chief Economist Brian Coulton.
“It’s interesting that the Fed’s projections now show the unemployment rate falling to its long-run level by 2022, a year earlier than in September projections and implying less of a need for sustained aggressive monetary policy accommodation right through the medium term," he added.
The tone remains cautious, according to Wells Fargo Investment Institute. The Summary of Economic Projections suggests members do not believe inflation will top 2% over the long term, and shows rates staying put through 2023, although 5 of the 17 participants see a rate hike in 2023, Wells Fargo noted.
