This Is What It Sounds Like When Doves Cry

As we expected, the Fed was about as dovish as it could be without delivering any new policy initiatives. The clear signal is that policy will remain accommodative as far as the eye can see, and that’s negative for the dollar.

WHAT DID THE FED DELIVER?

Despite delivering no change in policy, the Fed nonetheless sent an unequivocally dovish signal. Fed Chair Powell summed up the Fed’s stance in one succinct sentence: “We’re not thinking about raising rates or thinking about thinking about raising rates.” Below, we discuss what the Fed could have done, did, and could do in the future.

1. Unveil dovish Dot Plots and macro forecasts – DELIVERED TODAY, MORE POSSIBLE IN H2. The Fed skipped this exercise in March due to the rapidly changing situation with the pandemic. The first Dot Plots since December show no hikes through 2022. More importantly, not one member saw a rate hike in 2020 or 2021, and only 2 saw hikes in 2022. The Fed is united in the outlook for low interest rates, at least for now. The Fed’s 2020 GDP forecast of -6.5% is between the IMF (-5.9%) and the OECD (-7.3%), but its 2021 forecast of 5.0% is above both the IMF (4.7%) and the OECD (4.1%). Its 2020 PCE inflation forecast of 0.8% is between the IMF (0.6%) and the OECD (1.2%), as is its 2021 forecast of 1.6% compared to the IMF (2.2%) and the OECD (1.5%).

2. Tweak its forward guidance – SOME TWEAKS DELIVERED TODAY, MORE POSSIBLE IN H2. Powell’s unofficial forward guidance (“We’re not thinking about raising rates or thinking about thinking about raising rates.”) was brand new and pretty much says it all. Official forward guidance saw a minor tweak. When the Fed announced open-ended asset purchases back in March, it said they would be made “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions” and added that “will assess the appropriate pace of its securities purchases at future meetings.” Today, the Fed said it would continue asset purchases “at least at the current pace” to meet those same goals. In the future, the Fed may introduce some numerical economic targets for forward guidance but we’re not there yet.

3. Tweak existing asset purchase programs – NOT TODAY, POSSIBLE ANY TIME. As we’ve seen since March, the Fed is no longer constrained by the calendar in terms of taking policy action. Just last week, the Fed tweaked its municipal funding program to make more counties and cities eligible for aid. For now, we think metrics suggest that most asset markets are functioning more or less normally. If any distortions or dislocations crop up, we can be sure the Fed will act quickly to address them. Lastly, Powell said that the Fed is in the final runup to starting its Main Street Lending Program.

4. Introduce Yield Curve Control – NOT TODAY, POSSIBLE IN H2. Powell said Yield Curve Control (YCC) was discussed. He added that whether or not is would be useful is “an open question” and that discussions will continue in upcoming meetings. As we’ve noted in the past, if yields rise significantly, then Fed will more likely do YCC but we’re simply not there yet. We’re not sure what the 10year yield pain threshold is for the Fed. 1.0%? 1.25%? Whatever it is, it’s clearly not 0.80% as there was no sense of urgency from Powell.

5. Negative interest rates – NOT TODAY, VERY UNLIKELY IN H2. There was no mention of negative rates in neither the Fed statement nor Powell’s press conference. We will have to wait until the minutes to see if they were discussed at all. Minutes from the April FOMC showed that the concept wasn’t being discussed. We note that not one current FOMC member has advocated negative interest rates. With the economy seemingly on the mend, the case for negative rates has gotten even weaker and we just don’t think the Fed will ever go negative.

INVESTMENT OUTLOOK

True to form, the dollar sold off today. The greenback has tended to weaken on recent FOMC decision days. In 2019, DXY weakened on 5 of the 8 FOMC meeting days. In 2020, DXY weakened on all three scheduled FOMC meeting days so far and also on all three of the emergency meetings in March. Going back to the last two meetings in 2019, the dollar has weakened eight straight FOMC decision days. Given the momentum, DXY looks likely to test the March low near 94.65 soon. Likewise, the euro appears likely to test its high from March 9 near $1.15, while sterling appears likely to test its high from the same day near $1.3200. Further losses are possible near-term, please see Our Latest Thoughts on the Dollar.


Taking a longer perspective, we note the dollar typically does poorly at the onset of each round of QE before recovering. Looking back to the financial crisis, the Fed first started Quantitative Easing (QE) in November 2008 when it announced plans to purchase $600 bln of agency mortgage-backed securities (MBS). DXY fell around 12% over the next month but then recovered to trade even higher by March 2009. QE1 was extended in March 2009 with another round of agency MBS purchases worth $750 bln as well as $300 bln worth of longer-dated US Treasuries. DXY fell around 17% over the next eight months but then recovered nearly all its losses by June 2010.