Fed to evalute two options in the FOMC meeting, forward guidance more likely to come

In the US, the FOMC is meeting for the first time since the Presidential elections and encouraging news about vaccines.

The developments since the last FOMC meeting are remarkable. The extent of the pandemic financial incentive continues to be debated. Clarity is also needed as to whether rising Covid-19 infection rates are harming the economy again. While the current policy stance is not expected to change, economic projections will be carefully monitored to measure monetary policy expectations for 2021.


In fact, there are two options for the Fed: First, to show that the Bank’s additional QE measures are on the table without waiting for financial incentives that will come out. The possible action is expected to be a technical adjustment involving a change in the amount or maturity structure of the QE. Regarding the financial package, details of the package of 908 billion USD have been presented. There are still deep divisions over the package, especially as regards state benefits and employer protection shield. Therefore, after Biden's election as president of the Electoral College, it is also important who will have the Senate, and it becomes definite after the January 5th Georgia elections. The probability of the financial package passing in Congress is uncertain, it has the possibility to pass in Biden era. The second option is; passing this month by verbal forward guidance. Even if the Fed chooses this path, it seems that QE action will come in January or March meetings.


Of course, in this environment, whether the Fed takes action or not, it will have to maintain the general dovish stance. The assumption that the Fed will not increase interest rates until 2023 is a worst case scenario that does not include an economic recovery that will come with a vaccine or fiscal expansion into the equation. However, since it is not clear how long the transition period between the exit from the health crisis and the exit from the economic crisis will last, central banks have to use policies that are compatible with the bad situation scenario. ECB exemplified this by extending the asset purchases to 2022. To be able to talk about the exit from a crisis, we will need to link QE to economic recovery. However, the main effect of QE is currently appearing in financial markets. Excess liquidity creates speculative effect rather than speeding up the money cycle. If the vaccine can eliminate the health emergency then we will have a stronger chance to make the connection to real economic recovery.


When the vaccine eliminates the emergency and we observe an increase in money rotation in the economy, we would be able to talking about the normalization phase of policies. The basic opinion will be based on the fact that if 2021 passes well, the Fed will be able to pull the period of increasing interest rates by the end of 2023 closer. For this, the economy will have to undergo a recovery effect, the demand will approach normal conditions and individuals will have to spend with the effect of regular income instead of financial aid. Regular income would be available with the improvement of employment. In any case, normalization will first occur in the form of a gradual downsizing of the balance sheet, that is, tapering of government bond and MBS purchases, and then an increase in interest rates.

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