- FOMC will keep the stimulus firehose going
- NBER declares that a recession has begun, with the depth yet to be seen
- Treasury sells 10-year T-note with yield near 0.88%
FOMC will keep the stimulus firehose going — The FOMC at its 2-day meeting that begins today is expected to leave its main policy variables unchanged. The U.S. economy remains in very rough shape with a net plunge of 19.6 million payroll jobs. The FOMC needs to keep its stimulus firehose going full blast to encourage a rapid recovery of the economy and to keep optimism high in the financial markets. The FOMC has so far managed to prevent a systemic financial crisis, but there are still many risks in the muni, mortgage, and corporate bond markets, and it is far too early to assume that the coast is clear.
The main news out of this week’s meeting will be the Fed’s new set of macroeconomic forecasts, which were suspended during the pandemic crisis.
The market is expecting the FOMC to leave its current fed funds target range of 0.00%/0.25% in place until at least 2023. The federal funds futures curve indicates that the market is expecting a slight 3-4 bp dip in the effective federal funds rate from the current level of 0.07% to the 0.03-0.4% level in the latter part of 2021. The market is then expecting a slight rise in the funds rate to the 0.11% level starting in mid-2022. Even after that expected rise, the funds rate would still be below the 0.125% mid-point of the current funds rate target range of 0.00%/0.25%.
The Fed has convinced the markets for the time being that it will not adopt a negative funds rate target. Federal funds rate futures for 2021 were trading at -0.03% several weeks ago. However, the Fed then started a concerted PR campaign whereby nearly every Fed official that spoke publicly stated that the Fed was not considering negative rates. That PR campaign caused the 2021 fed funds curve to rise back above zero to its current level of 0.03%/0.04%.
The Fed’s view is that it does not believe negative interest rates have been effective overseas in Europe or Japan. The Fed also believes that negative rates would hurt bank profitability and individual savers. The Fed isn’t mentioning the obvious concern that negative interest rates could spark a run on America’s $2.5 trillion of money market funds and potentially cause a systemic financial crisis.
The FOMC this week is expected to start a discussion on the possibility of adopting a yield-curve control policy where it pegs the 2-year or 5-year T-note yield at a certain yield level as a means of maintaining an upward sloping yield curve, while also preventing longer-term yields from rising and hurting the economy. However, no decision on a yield-curve strategy is expected to be announced this week.
The Fed yesterday announced that it will expand its Main Street Lending program to smaller businesses, reducing the minimum loan size to $250,000 from $500,000. That was a welcome development since the PPP program was of limited use and only applied to small businesses. The Fed yesterday said that its Main Street Lending program would be open for eligible lenders “soon” and that the Fed would start buying bank loans under the program “shortly thereafter.”
The Fed is not expected to put any parameters on its unlimited QE program as yet. The Fed’s balance sheet has soared by $3.0 trillion (+72%) since the end of February to a new record of $7.2 trillion. The Fed’s balance sheet has soared to 33% of U.S. GDP from 19% before the pandemic.
NBER declares that a recession has begun, with the depth yet to be seen — The National Bureau of Economic Research (NBER) yesterday said that the prior expansion peaked in February and that the recession began in March. The NBER is the unofficial arbiter for dating recessions. The NBER said that it will consider the current economic downturn to be a recession even if it is unusually short in duration because of the expected depth of the downturn.
The market consensus is for a peak-to-trough recession of -11.2% in the first half of 2020, which would meet the commonly-accepted definition of a depression as a decline of more than -10%. The expected decline of -11.2% would be more than double the -4.0% decline seen during the Great Recession in 2007/09, which is currently the worst recession in post-war history.
Specifically, the markets are expecting Q2 GDP to fall by -10.0% q/q (-34.4% q/q annualized), adding to the Q1 drop of -1.2% q/q (-4.8% q/q annualized). The good news is that the market is expecting the recession to bottom out quickly with GDP gains of +3.6% q/q (+15.4% q/q annualized) in Q3 and +1.9% q/q (+7.9% q/q annualized) in Q4.
Treasury sells 10-year T-note with yield near 0.88% — The Treasury today will sell $29 billion of 10-year T-notes. This will be the first of the two reopenings of the 5/8% 10-year T-note of May 2030 that the Treasury first sold in May. Today’s $29 billion auction size is up by $4 billion from the Treasury’s last 10-year reopening in April and is up by $5 billion from the $24 billion 10-year reopening size that prevailed during 2019 and early 2020.
Today’s 10-year T-note issue was trading at 0.88% in when-issued trading late yesterday afternoon. The 10-year T-note yield traded in the very narrow range of 0.54%/0.78% during April and May but last week broke out to a 2-3/4 month high of 0.96% due to last Friday’s surprisingly strong May payroll report of +2.5 million jobs.
The Treasury will then conclude this week’s $52 billion coupon package by selling $19 billion of 30-year T-bonds on Thursday. The Treasury is not holding an auction on Wednesday due to the FOMC’s meeting announcement on that day.
