Fed to Stay the Course With Yield-Curve Control Likely Ahead

(Bloomberg) -- Federal Reserve officials are unlikely to signal any new moves at their meeting next week, though many economists expect they will turn to yield-curve control later this year, recruiting a tool not used in the U.S. since World War II.

Just over half of economists surveyed by Bloomberg said they anticipate the Federal Open Market Committee will eventually set target yields for certain maturities of Treasury securities. Of those expecting that step, most said the announcement would likely come in September, with two- or five-year maturities targeted.

Respondents to the May 29-June 3 poll also overwhelmingly expected no change to the Fed's benchmark interest rate at the conclusion of the Fed's two-day meeting Wednesday. As in April, economists didn't anticipate the Fed to lift rates off zero until 2023. They also expected no change at this meeting to the guidance the committee offers on the future path of rates or asset purchases.

The view wasn't unanimous. A few economists are expecting the Fed will at least signal the approach of a new stage, if not announce its intention to ramp up its bond purchasing.

Asset Purchases

“This meeting is going to mark the transition from triage toward recovery,” said Brett Ryan, senior U.S. economist at Deutsche Bank Securities in New York. “That means transitioning Treasury purchases from restoring market function and liquidity to traditional monetary accommodation so that financial conditions can allow for a faster recovery.”

The committee will release its first set of economic forecasts since December. Officials junked forecasts scheduled for release in March, judging the outlook too uncertain to make projections useful. The new forecasts, however, may still be viewed with extra skepticism.

That uncertainty also explains why little new is expected from the Fed this meeting. The central bank continues to work on launching a slate of emergency lending facilities, extending credit to companies as well as state and local governments. Six of nine programs are up and running. But until more of the economy is open again for business and until the outlook becomes clearer, additional efforts at monetary stimulus may be premature.

Options on that front would include the kind of shift in bond purchases that Deutsche Bank's Ryan expects to happen at this meeting. Since a mid-March market panic, the Fed has been buying Treasuries and mortgage-backed securities to keep those markets functioning smoothly. Officials are widely expected eventually to announce bond purchases aimed at lowering longer-term borrowing costs as a way of stimulating economic activity.

Yield-curve control would complement such a policy, and New York Fed President John Williams on May 27 said that officials are “thinking very hard” about using the tool.

However, in an interview with Bloomberg Television on May 29, Cleveland Fed President Loretta Mester, a voter this year on the FOMC, said it's probably too early to expect a decision on yield-curve control at the June meeting.

“Right now that's a discussion for the future phase,” she said.

Deflation Risks

Survey respondents assigned a median 25% probability to the likelihood the U.S. would see year-over-year core PCE inflation drop below zero for at least three consecutive months in the next two years. The U.S. hasn't experienced a similar bout with deflation in records going back to 1960. Core PCE, which excludes food and energy components, declined to 1.04% in the 12 months through April.

Most respondents anticipate many of the Fed's emergency lending facilities would end up doling out far less credit than the program limits. For example, the median expectation for the Primary Market Corporate Credit Facility is for just $65 billion in lending, compared with its $500 billion cap.

They did see more action coming for the soon-to-be launched Main Street Lending Program. Economists predicted it would hand out $325 billion in loans, still well short of its $600 billion limit.

The Municipal Lending Facility, whose scope was widened by the Fed on Wednesday to include smaller borrowers amid concern that it might not reach the neediest communities, was seen deploying $150 billion of the $500 billion in lending available.

Fiscal Policy

Asked about fiscal policy, economists agreed the Federal government needed to do more to support the U.S. economy. In their median response, they indicated $1.75 trillion in additional federal fiscal stimulus would be appropriate this year.

A narrow majority of 52% said Fed Chairman Jerome Powell should be more aggressive in urging Congress to provide more aid. Following the April 28-29 FOMC meeting, Powell was unusually outspoken on the matter, saying, “this is the time to use the great fiscal power of the U.S.”

But testifying before lawmakers on May 19, he was more cautious. “This is really a question for Congress to weigh,” he said.

Judging risks that face the U.S. economy as it begins recovering from the Covid-19 pandemic, respondents ranked a possible second wave of the virus as the biggest threat.