The Federal Reserve meets on December 15-16. We expect the Federal Open Market Committee (FOMC) will keep its fed funds rate unchanged at 0.00-0.25% and leave its pace of quantitative easing at USD120 billion a month of bond buying.
Weekly Economic Activity, US
Source: Bank of Singapore, Bloomberg
The charts show the US economy is recovering despite winter virus waves. But GDP is still around -2.0%YoY below its levels of a year ago and inflation continues to miss the Fed’s 2% goal. The FOMC is thus set to keep aiding the recovery with its current very loose monetary policy settings.
Officials, however, are likely to make three decisions in line with our view for Treasury yields to steepen modestly further to 1.20% for 10Y bonds over the next year and for the USD to keep falling to 1.25 and 6.30 against the EUR and CNY.
Source: Bank of Singapore, Bloomberg
First, the FOMC will tie its forward guidance on future bond buying to its goals of achieving 2% inflation and full employment.
Currently, the Fed says asset purchases will continue at the current pace ‘over the coming months.’ This time-based view is likely to shift towards outcome-based guidance signalling the Fed will only start tapering its quantitative easing when growth is on track to fully recover from the pandemic and inflation is meeting the Fed’s new target of averaging 2% a year. This will give the FOMC the flexibility to respond to changes in the outlook while avoiding early tapering in 2021.
Second, the Fed will likely refrain from skewing its bond purchases towards long term Treasuries. US 10Y and 30Y yields have picked up over the summer but still remain at historically low levels of 0.90% and 1.63% respectively. Thus, there is little need for the Fed to buy more longer-dated bonds to stop long end yields rising too quickly.
Third, the FOMC will update its Summary of Economic Projections (SEP) with policymakers’ new median forecasts still likely to show no rate hikes until at least the end of 2023. This will reinforce expectations that the Fed will not start lifting its fed funds rate from 0.00-0.25% for the next 3-4 years even if the central bank begins to taper its pace of quantitative easing from 2022.
We expect the FOMC meeting will thus push long term Treasury yields marginally higher while keeping the clear USD downtrend intact for 2021.Disclaimer applicable to recommendation
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