Gridlocked Washington Would Force Fed to Do More for Economy

The tightly contested U.S. election puts pressure on the Federal Reserve to deploy even more monetary stimulus to support the economy under a divided government.

The central bank is not expected to announce a shift in stance Thursday when Fed officials conclude a two-day meeting in Washington. But Chair Jerome Powell may hint at coming changes to the Fed’s bond-buying program, after chances of aggressive fiscal spending for households and businesses faded along with prospects of a Democratic government sweep.

Treasuries rallied Wednesday as investors marked down the odds of a generous stimulus package turning their attention to the Fed’s assets purchase plan.

“There are many possibilities as to what to do,” said Roberto Perli, a partner at Cornerstone Macro in Washington, citing concentrating asset purchases towards longer maturities, increasing asset purchases, revising the terms of the Main Street program once more and yield curve control.

“None of these options is likely to be particularly powerful or a good substitute for a robust fiscal program,” Perli said. “I think eventually the Fed will have to use at least some of them.”

The presidential race is still too close to call with Democrat Joe Biden opening a clearer path to victory over Donald Trump after winning Wisconsin, as vote counting continues in other battleground states. But Republicans look likely to retain control of the Senate. That dims the outlook for lawmakers agreeing significantly more fiscal measures in coming months, regardless of who wins the White House.

Long-term Treasury yields are already tumbling with less fiscal fuel also diminishing the need for a deluge of fresh supply. The Treasury Department announced Wednesday that issuance in the coming quarter wouldn’t be biased toward longer-dated securities, helping put more pressure on long-term yields relative to shorter-term ones. The drop in yields could limit the effectiveness of any fresh Fed action.

“A slowing in the pace of issuance should help bull flatten the curve amid expectations of divided government,” TD rates strategists Gennadiy Goldberg and Priya Misra said in a note.

Before the election, Powell and his colleagues were vocal about the need for more fiscal relief and the limits to what more the central bank could do for the economy with interest rates already expected to remain near zero for several years. That chorus included Fed Governor Lael Brainard, who is seen as a potential candidate for Treasury secretary in a Joe Biden administration.

But a worsening outlook would probably prompt the Fed to take another look at its bond-buying program, and the emergency lending facilities for “Main Street” businesses and state and local governments it rolled out earlier in the year, if additional action from lawmakers is not forthcoming.

Data released earlier on Wednesday showed U.S. service industries expanded in October at the slowest pace in five months and U.S. companies adding fewer jobs in October than forecast, reinforcing a picture of moderating economic growth that will require continued policy support.

The Fed is currently purchasing about $80 billion of Treasuries and at least $40 billion of mortgage securities a month to ensure smooth market function and keep financial conditions easy.

A shift could come as soon as December. Fed officials were already set to discuss their options at this week’s meeting, but diminished odds of fiscal stimulus will increase the urgency of additional measures.

Lack of additional fiscal support would reduce the efficacy of the Fed’s remaining tools, said Jonathan Wright, an economics professor at Johns Hopkins University. The aim of focusing the central bank’s bond-buying more toward longer-term debt would be to put downward pressure on longer-term interest rates, but they are already sliding due to weaker economic prospects, he said.

“Monetary policy would be able to accomplish much more if it were preventing the increase in bond yields that might otherwise occur following a large stimulus,” Wright said. “It can’t do much with a 10-year yield at 80 basis points.”

Source: Read Full Article