The Fed could disappoint the markets on Wednesday, even if it keeps a super dovish tone

The Fed may see better long-term prospects when it releases its economic forecast on Wednesday due to developments in vaccines, but it also has the potential to disappoint at least some investors who expect immediate changes to its program. purchase of bonds.

The market is split on whether the Fed would extend the duration of its $80 billion Treasury purchases, which means increasing long-term purchases, such as the 10-year note and the 30-year bond. Theoretically, this should help keep longer-term rates that impact mortgages and other loans down.

But a number of economists instead expect the Fed to simply give more information and direction on what would prompt it to make changes, saving the actual policy change for later. Rates for now are still low and financial conditions are supportive, and it remains unclear how much stimulus Congress will provide to the economy.

The Fed will release its statement at 2 p.m. and Fed Chairman Jerome Powell will hold a briefing at 2:30 p.m. ET.

Due to the divergent views, the Fed has the potential, with its statement on Wednesday, to move the markets. The bond market has bet to some extent on an increase in purchases of notes and bonds with longer maturities.

“Someone is going to be disappointed,” said Ian Lyngen, head of US rates strategy at BMO. “I think it will be a negotiable event one way or another.” But if that doesn’t change the bond program, he doesn’t expect the bond market to see a big move, since the Fed will still maintain the outlook by saying it’s ready to act.

“At the end of the day, they’re going to be dovish,” said Rick Rieder, chief investment officer of global fixed income at BlackRock. “The question is, are they going to be dovish or super dovish? [duration of purchases]? I don’t think it matters when they do, at this meeting or the next. I think they will.”

Rieder expects the Fed to eventually change the asset mix, but also increase the purchased Treasuries to $100 billion and cut the $40 billion in mortgages it is also currently buying.

“I think they’re very receptive to buying more assets,” Rieder said. “I think they will discuss doing it, rather than doing it.”

Rieder said he expects a stimulus package in the first quarter, although Congress continues to try to find a compromise this week. Any stimulus will cause the Treasury to issue a lot more debt, and the Fed is watching the magnitude of the package.

“I think we’re entering a new era of fiscal stimulus, borrowing and Fed involvement,” he said.

The current Fed bond-buying program is the pandemic crisis version of quantitative easing, first introduced by the Fed during the financial crisis. The Fed quickly reintroduced the program without the type of perimeters it used before. This had a powerful impact on the markets, which were stressed by the sudden stop in the economy last March.

Now the market expects more definition of how the Fed will use the program. Some Fed watchers say the Fed would be better served waiting to see what kind of stimulus package Congress develops before acting, and others, like Goldman Sachs, argue that the virus is spreading at a record pace. be a catalyst for the Fed to move.

“We believe the Fed is slightly more likely than not to extend the weighted average maturity of its Treasury purchases, although this is a close call,” they wrote. Goldman economists expect the Fed to get more for its money if it buys longer-maturity Treasuries rather than shorter maturities, which are more affected by its interest rate policy.

“We expect the FOMC to adopt earnings-based forward guidance indicating that buying will continue” until the labor market is on track to peak employment and inflation is on on track to reach 2%, “a more flexible version of the thresholds used for taking off the funds rate.” added the Goldman economists.

Citigroup economists see just a 25% chance the Fed will change the bond-buying program, while Bank of America economists expect the Fed to simply change the language of its program but refrain to act. “The next meeting will focus on language changes as we expect the FOMC to leave its policy rate and asset purchases unchanged. We believe that neither economic nor financial conditions are dire enough to warrant further easing. of politics right now,” the Bank notes. from America.

Diane Swonk, chief economist at Grant Thornton, said she thinks the Fed should keep its powder dry, not make changes but provide guidance on what conditions will move it.

“I think they should wait until they see if they have to pull the trigger. They are long-term bond holders. Once they’re gone, it will be more difficult to untie. You have to have a good reason to do it,” she said.

“I don’t think the Fed wanted to be in that position, but they didn’t define clearly enough what they intended. Anything we hear from them would give them the flexibility to do something by the end of the week if Congress goes home and does nothing. They don’t have to wait until January,” Swonk said.

Swonk expects the Fed to change the way it presents its economic forecasts as well, to provide more context around forecast risks. “You could have a revised higher forecast with more risk,” she said.

The Fed may note that the short-term outlook is weak due to the economic impact of the growing number of coronavirus cases across the country. But he may see better longer-term prospects because of the vaccines, which are just starting to roll out.

The Treasury clipped the Fed’s wings by refusing to extend some of its emergency programs and diverting funds to fiscal stimulus. The municipal bond and corporate bond facilities were closed at the end of the year, as was the Main Street lending program.

But Fed watchers expect that once the Biden administration takes over and former Fed chief Janet Yellen becomes Treasury Secretary, those programs could resume if the Fed believes that they are needed.

Rieder said the Fed is in a unique position with Yellen at Treasury and they could forge an important partnership.

“I think people understand that’s a big deal, especially as long as the two are going to be accommodating. The economy can handle more housing and more taxation, funded by the Treasury and backed by the Fed. “, did he declare.

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