There was no change to the target Fed policy range, though there was a 5bp increase on excess reserves (to 1.60%). There are no policy implications to draw from this increase, however. It is a technical change designed to help keep the Fed Funds rate in the middle of its target range.
Fed eager to avoid further repo drama
The Fed committed to ongoing repo operations through the tax payment season in April, with the aim of avoiding a repeat of last year’s infamous flare-up in repo markets.
The operations conducted so far have increased the size of the Fed’s balance sheet by increasing excess reserves in the system through T-bill purchases. After Q2, however, we expect T-bill purchases to slow significantly, potentially stabilizing the size of the Fed’s balance sheet as a percentage of GDP.
Figure 1: Expect the Fed’s balance sheet to stabilize from Q2
Source: Bloomberg as of January 29, 2020.
Policy is still “appropriate” and cuts look unlikely in 2020
Committee members continued to deem policy as “appropriate”, a sign they are comfortable that the three 2019 cuts have met the objective of sustaining the expansion. Markets nonetheless continue to price in at least one more cut this year. However, we believe further accommodation this year is unlikely.
Growth indicators could help keep the Fed comfortable
We expect GDP to be around 2% this year, with personal consumption, housing markets and government spending all looking supportive.
Although the new coronavirus scare has introduced a source of uncertainty that we (and the Fed) are monitoring, we do not currently anticipate a material pass-through effect on US GDP. Other risks include shutdowns in the aerospace sector, which will likely negatively impact GDP in Q1, but we believe the Fed will look through such distortions, provided there are no spillover effects on other sectors.
Inflation could well trend towards the Fed’s target
At his press conference, Chairman Powell emphasized that the Fed is “not comfortable” with inflation being “persistently below” target. This may not be a continuing issue as we expect that inflation may accelerate towards the Fed’s 2% target this year, given continued labor market tightening and pressure from wage growth.
All-in-all, we believe there is now a relatively high bar for further policy accommodation.
Please note: any forecasts or opinions expressed herein are Insight Investment's own as of January 30, 2020 and subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.