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Home / Business / With a balance in the background, the markets focus on the Fed's interest rate policy

With a balance in the background, the markets focus on the Fed's interest rate policy



(Reuters) – When Federal Reserve officials close their two-day police meeting on Wednesday, they may finally have succeeded in separating the actions they take to steer the US central bank's massive balance sheet from interest rate decisions.

FILE PHOTO: Federal Reserve Building Depicted in Washington, DC, USA, August 22, 2018. REUTERS / Chris Wattie

That would be a stark contrast from a year ago when Fed leader Jerome Powell's comments on that the reduction in the balance was on "autopilot" gave investors the impression that the central bank was on a strict course to tighten monetary policy, without the flexibility to address the concerns of the market's liquidity or slow down global growth.

Since then, the Fed has changed its course, both in politics and in messages.

It went from raising the rates to cutting them. Officials went from shrinking the balance by $ 50 billion a month, which was seen as an action to tighten the policy, to growing it by $ 60 billion a month. And they did so with a strong message that buying short-term bills is not meant to "have any meaningful effects" on the economy. The balance is now at almost $ 4 trillion.

Investors awaiting updates from the Fed on Wednesday are now free to focus on what is usually the main attraction for the policy meeting: the direction of interest rates.

The Fed's policy committee is largely expected to announce a cut of quarterly percentage points in the central bank's lending rate overnight when it releases its latest policy statement at 2 pm. EDT (1800 GMT). Powell will hold a news conference to elaborate on the decision half an hour later.

An interest rate cut would be the third this year and would bring the key rate to a target range of 1.50 to 1.75%. Investors will also set clues as to whether policy makers feel they have acted correctly to address potential headwinds to the US economy, or whether more relief is needed.

Some economists say that the effort to separate the discussion of balance from the issue of monetary policy seems to be working.

"I think the two issues are separate and they will and will continue to try to reinforce it," said Karim Basta, chief financial officer for III Capital Management. "My main interest at the next meeting is more about interest rate policy and how they can influence risk."

The Fed messages are intended. In its response to the recent recession, it linked the huge purchases of government bonds and mortgages with security, with a clear forward view that the goal was to lower long-term interest rates and stimulate the economy.

This time, officials call the purchases a "technical adjustment" and have covered almost every mention of the initiative with a reminder: This is not quantitative relief.

"The Fed's toolbox not only increases or lowers the federal fund rate – it's also how they interact with the markets," said Nela Richardson, an investment strategist with Edward Jones. "Words matter."

NOT SO LASY

The balance sheet expansion program announced in mid-October is part of a joint effort by the Fed to avoid a repeat of the mid-September liquidity crisis that led to a spike in short-term borrowing rates. The tax funds, combined with daily repo operations, are intended to solve the liquidity problems so that they do not get in the way of the Fed's main job of setting monetary policy.

But some investors say it is not so easy to completely isolate the large asset purchases.

"They try to send the signal to everyone else to think of them as separate," said Lewis Alexander, chief U.S. economist in Nomura. "I honestly have a problem with that."

Alexander said he wants more clarity on how the Fed decides what assets to buy when managing its balance sheet. "I just don't understand how they think about this decision," he said.

The Fed's efforts to improve financial market liquidity can stimulate the economy by increasing investors' prospects, says Julian Emanuel, chief strategist and derivatives for BTIG. Some financial firms may feel more comfortable investing if they believe the markets work smoothly, he said.

By snapping up short-term government bonds, the Fed also helped to reverse the so-called inverted yield curve, which occurs when the yield on long-term bonds falls below those on short-term bonds. The pattern is usually seen as a red flag for the economy because it has been ahead of every recession since the late 1950s. Some people may take the recent escalation as a sign that the recession is slowing, Emanuel said.

However, concerns remain about the central bank's plan to ensure that money markets run smoothly through the end of the year and beyond.

FILE PHOTO: Federal Reserve Chairman Jerome Powell holds a news conference following a closed two-day Federal Open Market Committee meeting in Washington, USA, September 18, 2019. REUTERS / Sarah Silbiger

For example, some investors may wish to know how much officials discussed the possibility of creating a standing repo facility, said James McCann, senior economist at Aberdeen Standard Investments.

The Fed calmed the money markets in mid-September by injecting cash into the overnight loan markets for cash, operations that will continue into next year. But some investors say they still have questions about what caused the volatility.

"It doesn't give you confidence," said Quincy Krosby, chief marketing strategist for Prudential Financial. "The problem may be more systemic than the Fed suggests."

Reporting by Jonnelle Marte; Editing by Paul Simao

Our Standards: Thomson Reuters Trust Principles.

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