Boston - The Federal Reserve has continued to tweak its monetary stimulus programs to make them more market friendly — changing some, getting rid of others and adding new ones. As I have said over the past several months, the Fed is unlikely to give up until it gets it right.
Its efforts are within the framework of trying both to improve market functioning and provide bridge financing. In addition to its various programs, the Fed has announced a significant increase in its balance sheet, which has expanded dramatically with its large purchases of Treasurys and mortgage-backed securities. However, that pace has slowed down somewhat over the past month as the market stabilized. Nonetheless, the balance sheet is still increasing and going forward, I believe we are at a transition point for monetary policy.
Inflation subdued for now
In order to improve market functioning, I believe the Fed will continue to tweak some of its credit programs, but I expect them to focus more on trying to increase medium-term inflation expectations. This is something it had been discussing mostly as an academic concept before the crisis hit, and some type of permanent quantitative easing (QE) or bond-buying program will likely continue indefinitely.
Some might argue that permanent QE is the same as debt monetization, and I would agree with this view as I think the lines between fiscal and monetary policy were very blurry coming into the COVID-19 crisis, and are likely to get even blurrier going forward. The Treasury's recent announcement regarding large supply was met with a modest pickup in yields and a steepening of the yield curve. This could certainly continue, although yields have moved somewhat lower since that initial sell-off.
More talk about negative interest rates
Recently, there has been more market chatter on negative interest rates, although there has also been pushback on this from many Fed officials. I think the Fed under current leadership will do its best to push back on negative rates, which they believe aren't that effective and have some significant negative side effects.
While pushing back against negative rates is becoming more of a consensus view among the global central banking community, there is certainly a vocal minority that continues to push for negative rates. If one of these negative rate advocates — such as former IMF Chief Economist Ken Rogoff, for example — took over from Jerome Powell as head of the Fed, then I could certainly see the Fed going to a negative rate policy.
Bottom line: That being said, I do expect the Fed will likely do its best to cap interest rates — and in particular, real interest rates — going forward.