FOMC adopts new policy strategy
- August 31, 2020
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
SummaryThe major U.S. equity indices moved higher on the week with the S&P 500 notching its fifth consecutive weekly gain amid positive COVID-19 vaccine developments and a host of encouraging economic data releases.
Prior week summary
The major U.S. equity indices moved higher on the week with the S&P 500 notching its fifth consecutive weekly gain amid positive COVID-19 vaccine developments and a host of encouraging economic data releases. In a highly anticipated announcement, the FOMC announced a change to its policy strategy on Thursday, opting to ditch its 2% inflation objective in favor of an average inflation target of 2%. The policy change was unanimously approved by all 17 top Fed officials and signals a more accommodative stance from the Federal Reserve as they add flexibility to the timing of future rate moves. In a statement released with the decision, the FOMC said, “The Committee seeks to achieve inflation that averages 2% over time and therefore judges that, following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” The change comes after years of falling short of its 2% inflation objective. While a mathematical calculation to determine this new 2% average goal was not released, St. Louis Fed President James Bullard suggested that such a calculation was not needed saying, “This is a very large committee as you know, with many opinions. So I don’t think you want to get into precise mathematical formulas here. But the spirit of this is that, in the committee’s judgment, it would be wise to allow inflation to be above targets for some time to make up for past misses.” On the economic data front, market participants received a deluge of economic data updates that largely pointed to a recovering U.S. economy. The housing market continued to see encouraging trends with new home sales at 901,000 in July, far above both consensus expectations and last month’s 791,000 figure. Durable goods orders smashed expectations after seeing an 11.2% increase in July, above the 7.7% pace seen in June. According to the second estimate of second-quarter GDP released by the Commerce Department, the U.S. economy shrank at an annualized 31.7% pace in the second quarter. Jobless claims continue to remain historically elevated with 1.01 million individuals filing for unemployment in the last week. Continuing jobless claims declined week over week to 14.54 million claims.
As of Sunday evening, the U.S. infection tally stands at 6.18 million cases, nearly a quarter of the global tally and a 5.1% increase week over week, with just over 187,000 individuals succumbing to the virus. After experiencing a surge in cases across the southern U.S. and California, cases have continued to decline in recent weeks with Florida seeing a 26% week over week decline and California and Texas seeing a 29% decrease in new cases over the same period. While the U.S. remains the most afflicted nation by confirmed case count, the 49,000 new cases reported on Friday is far below levels seen at the end of July amid the southern outbreak. After experiencing a modest rate of COVID-19 infections over the summer, many European countries, including France, Germany, and Italy, are now beginning to see an increase in infections and hospitalizations. On Thursday, France reported approximately 7,300 new cases, a figure not seen since the early days of the pandemic. While President Emmanuel Macron emphasized the need for social distancing and precautionary measures when speaking with reporters on Friday, he indicated that his government will do “everything to avoid a new lockdown.” FDA Commissioner Stephen Hahn turned heads last week after indicating that the FDA could fast track approval for a COVID-19 vaccine prior to the conclusion of Phase III trials in order to get the vaccine to the public as fast as possible. Speaking of a possible emergency authorization, Hahn said, “It is up to them to apply for authorization or approval, and we make an adjudication of their application. If they do that before the end of phase three, we may find that appropriate. We may find that inappropriate, we will make a determination.”
The look forward
Market participants are gearing up for a busy week of economic data releases with updated figures on the ISM Manufacturing Index, ISM Non-Manufacturing Index, ADP employment report, factory orders, jobless claims, and the August non-farm payroll report dotting the economic calendar.
Market implied policy path (Overnight indexed swap rates)
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Increase lending capacity
Many financial institutions have excess liquidity due to the global pandemic and resulting economic stimulus. Management can deploy this liquidity into new loan originations or the investment portfolio. Although bond returns are better than cash, a more attractive return may be provided from mortgage loans.