- FOMC policy today expected unchanged but any news awaited on T-bill purchases and IOER rate
- Chinese stock markets will remain closed on Friday
FOMC policy today expected unchanged but any news awaited on T-bill purchases and IOER rate — The FOMC at its 2-day meeting that ends today is unanimously expected to leave its funds rate target unchanged at 1.50/1.75%. The FOMC today will not issue a new set of economic projections or Fed-dots but Fed Chair Powell will deliver his usual press conference after the meeting.
The FOMC today is expected to stick to its theme that policy will remain unchanged unless there is a “material reassessment” of the economic outlook. Since the FOMC’s last meeting on Dec 10-11, there has been mixed news. On the favorable side, the U.S. and China reached a phase-one trade deal on Dec 13 and then signed that deal on January 15. Also, the Brexit withdrawal process by Friday’s deadline is a done deal and the next major Brexit uncertainty doesn’t arise until the end of 2020 when the transition period ends.
On the negative side, the spreading Chinese coronavirus has put a big dent in global confidence and Chinese GDP. However, the impact has been confined mainly to China so far and the situation for the U.S. is not bad enough at present to force the Fed into a rethink of its policy.
Although the Fed today will certainly leave its funds rate target unchanged, the markets are nevertheless watching for news on two important topics, i.e., the IOER rate and the Fed’s T-bill purchase program.
There is speculation that the FOMC today may announce a +5 bp hike in its IOER (interest on excess reserves) rate by 5 bp to 1.60%. The IOER rate normally acts as a floor for the funds rate. The funds rate has recently been trading near the lower end of the FOMC’s 1.50-1.75% target and the Fed may therefore want to push the IEOR rate up to 1.60% so that the funds rate starts trading closer to the target midpoint of 1.625%. The funds rate has recently been trading on a soft note due to the Fed’s massive repo injections and T-bill purchases. A hike in the IEOR rate today would be a technical move and would not have any implications for the future direction of Fed policy.
The markets remain very interested in the Fed’s T-bill purchase program, which began October 1 with the purchase of $60 billion of T-bills per month. A Bloomberg News survey found that 68% of economists surveyed believe that the Fed’s T-bill program has lifted equity prices.
Due to the T-bill purchases, the Fed’s balance sheet has risen by a total of $386 billion from the 6-year low seen in August 2019, reversing about half of the overall drawdown of the balance sheet seen during 2015-19. The Fed’s permanent injection of $386 billion of reserves since October has provided liquidity to support gains in the stock and bond markets.
The FOMC has said that its T-bill purchase program will continue until at least Q2. The market consensus is that the program is likely to end in June. The markets will then find out if the stock market starts to struggle once the Fed’s liquidity injections stop.
The Fed denies that its T-bill purchase program constitutes quantitative easing since the Fed says that QE occurs only when the Fed is buying T-notes that will stay in its portfolio longer. However, the definition of QE is largely a matter of semantics. When the Fed buys T-bills, it injects the same amount of liquidity over the short-term as it does when it buys T-notes, meaning there is little functional short-term difference between buying T-bills or T-notes.
The most recent set of Fed-dots, released at the last FOMC meeting in December, contained a median forecast that the funds rate will be unchanged this year and that there will then be a +25 bp rate hike in 2021 and a second rate hike in 2022. A survey by Bloomberg News found a median forecast among economists for no rate changes at least through 2022.
However, the federal funds futures market continues to be considerably more dovish than the Fed or Wall Street economists. The futures market is expecting the funds rate to average 1.27% in December 2020, which would represent a -35.5 bp cut in the funds rate (i.e., 1.4 rate cuts) from the current target midpoint of 1.625%.
The market is not fully expecting this year’s rate cut until September. The market is discounting smaller chances of that rate cut of 26% by March, 38% by April, 64% by June, and 80% by July.
Chinese stock markets will remain closed on Friday — The Chinese stock exchanges confirmed that they will remain closed this Friday and will reopen on Monday, Feb 3. China’s stock markets had previously been scheduled to reopen this Friday after having been closed since last Friday due to the Lunar New Year holiday.
The iShares MSCI China ETF (MCHI) on Tuesday halted the week-long free-fall and closed the day up +1.00%. The China ETF on Tuesday’s high rebounded higher by a total of +3.7% from Monday’s 1-3/4 month low, but the ETF on Tuesday still closed -8.6% below the pre-virus Jan 17 close. Chinese stocks rebounded mildly higher on Tuesday on hopes that China’s various actions such as quarantining some 45 million people will curb the spread of the virus.
Yet the virus has a long incubation period of up to 14 days before the patient shows symptoms and the virus is contagious before the symptoms emerge. That means it will be a number of weeks before it becomes clear whether the virus is spreading at an exponential rate or whether the infection rate starts to slow. It took about eight months for the SARS pandemic in 2002/03 to be fully contained.
