Over the weekend we showed in simple terms why the Fed will have to adjust – and expand – its QE: as the following BofA table makes abundantly clear, in a time when foreign demand for US Treasurys continues to decline (with China’s current account moving into a deficit, it will be far more focused on finding its own foreign investors rather than funding US deficits), the US is set to issue a net $2.4 trillion while the Fed will monetize less than $1 trillion of this, a stark reversal from 2020 when Jerome Powell is purchasing every dollar of debt sold by Mnuchin.
So unless the Fed is prepared to allow Treasury yields to rise far higher in order to create the required excess demand for US paper to fund the massive 2021 deficit, it will be up to the Fed to aggressively increase its QE, although it may need another “crisis” as a catalyst to announce this expansion.
And while a crisis is unlikely to take place before the next FOMC meeting on December 16, JPMorgan is already taking the next step of projecting that in an interim step extending the duration envelope of QE, and now sees the Fed to extend the maturity of its Treasury purchases.
Here is what the bank’s chief economist Michael Feroli wrote this morning: “We now look for the Fed to extend the maturity of its $80 billion monthly purchases of US Treasuries at the December FOMC meeting.”
But why? after all stocks are currently trading at all time highs and the economy is rapidly mending? How will the Fed justify yet another monetary expansion? Simple: the $2 trillion fiscal injection is not coming any time soon, if ever, which means that the only game in town remains Brrrrr. Only instead of telling the truth, Feroli decides to take the circuitous path to justify his assumption, stating that there are “considerable downside risks” to the economy due to the surge in covid cases, completely ignoring the fact that a covid vaccine is now just around the corner. If only stocks shared his pessimism:
The recent surge in virus case counts presents a considerable downside risk to the near-term economic outlook. While markets are more focused on the medium-term outlook, where vaccine hopes are rising, recent Fed rhetoric has indicated growing concern about the months between now and when a vaccine is widely available. Moreover, the apparent success of the monetary and fiscal response this spring is a reminder that minimizing short-run risks can lessen the degree of longer-run damage to the economy. At the most recent post-FOMC meeting press conference, Chair Powell indicated that the Committee thought the degree of accommodation they were providing was appropriate. However, the accelerating spread of the virus may be changing that assessment, and last Thursday Powell indicated that this spread implies that Congress and the Fed will likely need “to do more.”
While that cover the bulk of Feroli’s revised forecast, he padded it with the following:
There are a number of ways the Fed can try to do more, but we believe the approach which is most likely to gain consensus on the Committee is the one offered by Boston Fed President Rosengren: leave the notional monthly purchase pace unchanged but lengthy (sic) the weighted average maturity of their Treasury purchases. The rationale for such a move is simply to put more downward pressure on longer-term interest rates and thereby encourage more interest-sensitive spending.
In other words, take the already biggest asset bubble in the world and make it bigger:
He goes on:
The recent backup in longer-term interest rates actually increases the scope for this strategy to be successful. To the extent this backup has been driven by an increase in term premium (as in the ACM model), this further strengthens the case that extending the maturity of purchases will place downward pressure on rates. As our colleagues in interest rate strategy recently noted, the Fed could potentially double the weighted average maturity of their current purchases.
At any rate, we believe the general policy shift will be announced in the December FOMC statement, with the details announced in an accompanying NY Fed operating policy statement. Finally, as we noted after the last FOMC meeting, the Federal Reserve Board may be running into legal and political challenges extending the various credit facilities beyond their current December 31st expiration date. If this remains the case this should further support the argument for the Fed doing more where it can operate with fewer constraints: in its asset purchase programs.
Since none of this does anything to expand the total monthly Treasury monetization, what JPM is focusing on is merely an interim step before the next crisis hits – sometime in Q1 – at which point the Fed, already gobbling up 10Y, 20Y and 30Y bonds, will announce it is expanding its $80BN in monthly TSY purchases to $160BN or more, just so the current status quo in which the Fed monetizes the entire US budget deficit, continues.
The only questions, as we laid out over the weekend, is what the next crisis big enough to enable more QE, will be and who will spark it?
Finally, for all those who only came here for the cartoons, here is an explanation of what’s going on.
— Makkan (@MarcusNrUNO) November 16, 2020