June 2020 FOMC Meeting
Backdrop
Market expectations ahead of June’s FOMC meeting were largely for unchanged policy and guidance reflecting a downbeat and outcome-dependent tone. Short rate markets were pricing the federal funds rate to remain at 0.0-0.25% until the end of 2022, indicating that the revised Fed “dot” plot – the first since December 2019 – would point to no rate hikes for the foreseeable future. The IOER rate was expected to remain at 0.10%. Guidance around asset purchases was also expected to remain flexible, indicating purchases would continue “in the amounts needed.”
The Fed confirmed its accommodative stance, keeping interest rates unchanged, indicating no rate hikes are expected until 2023 at the earliest, and confirming the bank will continue asset purchases “at least at the current pace.” While it noted the improvement in financial conditions, its economic projections were sobering: it expects the US economy to contract by 6.5% this year before bouncing back modestly in 2021 by 5%. The unemployment rate is projected to hit 9.3% this year before falling to 6.5% in 2021. PCE inflation is projected to be solidly below its 2% target, at 0.8% this year and 1.6% next year. During the press conference, Chairman Powell noted that Fed projections have a “high level of uncertainty,” as well as noting that yield curve control remains “an open question.” He struck a dovish tone, noting that FOMC members are “not thinking about raising rates. We’re not even thinking about thinking about raising rates.” He also acknowledged the surprising jobs report as a positive but cautioned that a long road was ahead.
Market Impact
The slightly dovish tone was initially well received by risky markets. The S&P 500 index rallied and the USD fell against both developed and emerging currencies while the 10-year yield on US Treasuries continued its downward trend from earlier in the day. However, Chairmain Powell’s dour tone in the press conference pushed equity prices down and put further downward pressure on the 10-year yield.
Asset Allocation Consequences
Monetary and fiscal responses following the COVID-19 crisis have been unprecedented in size and scale. This Fed meeting was further evidence that central banks will continue to do “whatever it takes,” supporting risk premia broadly. The Fed is clearly ahead of other central banks with its balance sheet now in excess of USD 7tn and likely to continue expanding to 50% of US GDP. Earlier this month, we saw the ECB increase its stimulation by pouring an additional EUR 600bn into the Pandemic Emergency Purchase Programme and extending purchases until at least June 2021. Nevertheless, the response is not uniform: other central banks such as the Norges Bank have indicated that recent rate cuts will be their last.
With this in mind, our current dynamic assessment articulates around three risk factors:
- Macro: The COVID-19 crisis is one of the largest macroeconomic shocks since the Great Depression. However, given the unprecedented monetary and fiscal response and the re-opening of economies, we view the current situation as more balanced. Contrary to previous recessions, the current shock could be short-lived. Our proprietary Growth Nowcaster indicators have recently shown that the worst is likely behind us. At the same time, our proprietary Growth Newscaster has recovered strongly but has recently stabilised, pointing toward a balanced growth environment. On the whole, we expect the macro situation to continue to improve from here.
- Market Sentiment: Sentiment is gently improving as economies re-open, and market stress is declining. Even recent heightened geopolitical tensions have failed to derail this improvement. Cash levels remain high and there is still plenty of room for systematic strategies to add beta participation. The Fed’s prolonged support should further improve investor sentiment.
- Valuation: Growth assets remain attractive in spite of the recent rally while real assets are on the expensive side. Large dispersions remain across both sectors and countries.
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