The FOMC minutes from the September meeting noted an improvement in US growth forecasts, however highlighted that this has been based on the assumption of fiscal support. The minutes said: “Many participants said that if future fiscal support was significantly smaller or came significantly later than they expected, the pace of recovery could be slower than anticipated.” The minutes also warned “that the absence of further fiscal support would exacerbate economic hardships in minority, lower-income communities." Adding that they “also were concerned by a possible build-up of financial imbalances."
In a case of “what a difference a day makes” Trump yesterday called for a piecemeal fiscal stimulus plan. However, despite equity markets charging higher and USTs selling-off, following the news, markets will soon realise that the economy needs more than just a piecemeal token. So, with the contentious and a sufficient fiscal package still a long way from being agreed, the FOMC may have to once again revise their forecasts at the next, post-election, meeting in November.
The central bank minutes also highlighted the possibility that small to medium businesses, not considered good borrowers, would come under pressure as banks will not lend to them, moreover, small- to medium-sized banks may also default.
In terms of inflation, although the FOMC recognises that inflation is gathering pace, it is still subdued and has a way to go before the central bank needs to concern itself. Of note, the deflation trade appears to be out of favour as market makers have recently started pricing in an inflation overshoot instead. According to the inflation options market, the 5-year inflation swap is currently trading around its pre-pandemic levels.
The minutes highlighted that “participants judged that given very low long-term rates, there did not appear to be a need for enhanced forward guidance at this juncture or much scope for forward guidance to put additional downward pressure on yields." Adding, “These participants were concerned that enhanced forward guidance could limit the committee’s flexibility for years."
Following the meeting in September, market makers appeared disappointed, having expected an update on the central bank’s bond-buying programme. On this, “participants noted in future meetings it would be appropriate to further assess and communicate how asset purchases could best support the achievement of the committee’s goals." We also heard from Chicago Fed President Evans yesterday, who said the central bank has “the capacity to do more asset purchases” but there is no immediate need, currently.
Interestingly, the “FOMC voters generally agreed its guidance expressed its assessment of the most likely rate path but not an unconditional commitment." As this path is now based on the relationship between higher inflation and lower employment, forward guidance on rates is bound to change as the two elements evolve.