Fed Shifting Focus From Crisis Management to Easy Financial Conditions

We expect the Federal Reserve will continue to conduct asset purchases at its current pace through year-end, and eventually commit to keeping interest rates on hold through 2022. This should help ensure easy financial conditions and support the economic recovery.

The messages coming out of the June FOMC (Federal Open Market Committee) meeting have not dramatically changed PIMCO’s outlook for Federal Reserve policy: Over the coming months, we expect the Fed’s focus will continue to shift from one of crisis management to one of keeping financial conditions easy. And as its objective shifts, the Fed will likely provide additional, more tangible, guidance on the path of monetary policy, including the path of interest rates and asset purchases. A yield curve targeting policy later this year is a distinct possibility. According to the June summary of economic projections (SEP), the majority of FOMC members expect to keep the policy rate at the effective lower bound through 2022. The committee also clarified that, for now, it will continue to purchase U.S. Treasuries and agency mortgage-backed securities (MBS) “at least” at the current pace – in line with our expectations.

Steady state of asset purchases should support easy financial conditions

Since mid-March 2020, when the Fed stepped in to help stabilize severe dislocations in U.S. Treasury and agency MBS markets, the Fed’s System Open Market Account (SOMA) has swelled to over $7 trillion (up from a $3.7 trillion trough in September 2019). More recently, as markets have pulled back from the brink, the Fed has gradually reduced its pace from purchasing $375 billion in Treasuries per week in early April to roughly $20 billion per week currently. Agency MBS purchases have exhibited a similar pattern.

On Wednesday, the Fed confirmed it will continue asset purchases at least at the current pace, while maintaining flexibility to adjust the pace as warranted by changing market conditions. We believe the Fed will purchase at the current pace of $80 billion per month in Treasuries and roughly $40 billion per month in agency MBS (net of prepays) until it is confident in the U.S. recovery – meaning at least through year-end 2020.

As we mentioned in our blog post following the April FOMC meeting, this purchase pace should offset much of the additional agency MBS and Treasury issuance that we expect in 2020 from the various pandemic relief measures.