Wells Fargo Research Team
Wells Fargo
Don't Expect the FOMC to Make Any Big Changes at Next Meeting
When the Federal Open Markets Committee (FOMC) meets in the first week of November there will be many things it is eager to see but few of which will be in clear focus at that point. The paramount concern is the state of the economy, which continues to expand albeit at a significantly slower pace than in the third quarter.1 It has only been six weeks since the September 16 FOMC meeting, which itself came on the heels of a seminal development at the Kansas City Fed's annual Jackson Hole symposium in August when Fed Chair Jerome Powell announced the adoption of a flexible average inflation targeting regime. On that basis, we are not bracing for any major shift in policy or forward guidance at the November FOMC meeting.
The FOMC meeting concludes on November 5, within 48 hours of Election Day on November 3. With mail-in votes expected to play a larger-than-usual role amid the pandemic, the outcome of the election could still hang in the balance from the top of the ticket to down-ballot races. Various Fed speakers in recent weeks have stressed the economic need for additional fiscal stimulus, and the outcome of the election has the potential to influence the complexion and timing of future stimulus.
In this edition of our Flashlight for the FOMC blackout period, we discuss how even in the absence of major fiscal policy developments, the Federal Reserve has a few potential remedies at its disposal for a still-ailing economy and low inflation. These include ramping up its asset purchase program or further easing the terms of its emergency lending programs, such as the Main Street Lending Program (MSLP) and the Municipal Liquidity Facility (MLF). The September meeting included an update to the so-called dot plot and the Summary of Economic Projections (SEP), as well as the initial rollout of 2023 forecasts from FOMC members. We also discuss what these projections might mean for Fed asset purchases in the months ahead.
Will the FOMC Soon Try to Speed up the Return to 2% Inflation?
The FOMC is expected to be in a holding pattern at the November meeting, but economic conditions generally, and inflation specifically, could press members to announce accommodative steps in upcoming meetings. The September SEP showed FOMC members generally expected a somewhat stronger recovery in GDP and the labor market compared to June. However, the bulk of the committee did not expect inflation to reach its longer-run goal of 2.0% until 2023. Even then, most members did not expect inflation to exceed the Fed's goal, which would be needed in order for inflation to average 2% over time, as per the committee's recently updated Longer-Run Goals and Monetary Policy Strategy (Figure 1). Between now and 2023, only two of the seventeen committee members anticipated inflation surpassing 2.0% in any given year.
Source: U.S. Department of Commerce, Federal Reserv e Board and Wells Fargo Securities
Importantly, according to the minutes of the September meeting, "many" members' outlook for the economy assumed additional fiscal stimulus to be coming down the pike. Over the past couple of months, there has been a steady stream of comments from Fed officials suggesting more fiscal support is crucial to the next leg of the recovery, and that fiscal policy is a better tool to support the economy at this juncture given the nature of this crisis. With another fiscal package yet to be secured, its size uncertain and its timing increasingly pushed back, a "substantial majority" of participants considered the risk to the inflation outlook as tilted to the downside.
The window for another fiscal package before the election or next January is quickly closing. Moreover, even if lawmakers were able to deliver an agreement soon, a three-year wait for inflation to return to 2% may prove too long for some Fed officials. Therefore, the FOMC is likely to look harder at additional ways in which it can support the recovery at its upcoming meeting.
Further asset purchases are likely at the top of the list, in our view. Currently the Federal Reserve has been buying roughly $80 billion of Treasury securities and $40 billion of mortgage-backed securities (MBS) each month. We believe it is premature to expect an announcement of additional asset purchases at the November FOMC meeting. The election results may be unknown, and we suspect the committee would like to see more data on how a "third wave" of COVID cases is affecting economic activity. In addition, Treasury yields remain extraordinarily low, watering down the impact of additional purchases at the moment.
That said Treasury yields have started to grind higher (Figure 2). With the tenuous outlook for inflation, the FOMC may feel compelled to do something soon, and it could potentially announce an increase in Fed purchases as early as its subsequent meeting on December 15-16. While current asset purchases are being undertaken in part to help market functioning, the primary intent of additional asset purchases at this point in time would be to achieve the committee's employment and inflation goals, with purchases therefore likely to be focused on the longer-dated Treasury securities.
What Ever Happened to Those Emergency Lending Programs?
When Congress passed the CARES Act in late March, it included $454 billion for the Federal Reserve to "make loans and loan guarantees to, and other investments in, programs or facilities established by the Board of Governors of the Federal Reserve System...that supports lending to eligible businesses, states, or municipalities." This sizable pot of money was designed to serve as a massive equity infusion into the Federal Reserve to facilitate new types of lending programs/asset purchases outside of traditional, government-backed assets like Treasury securities or mortgagebacked securities.
Perhaps the three most headline-grabbing programs to spring from this equity base were the Main Street Lending Program (MSLP), for lending to small- and medium-sized businesses, the Municipal Liquidity Facility (MLF), which is to be used for lending to state and local governments, and the Corporate Credit Facilities (CCF) for purchases of corporate bonds on the primary and secondary markets. These three areas were segments of the financial sector in which the Federal Reserve had historically played little to no role when it came to direct lending. With the potential to lever up that $454 billion into trillions of dollars, the central bank had the firepower to become a big player in these credit markets overnight.
Fast forward to today, and the actual amount of assets the Federal Reserve has taken on to its balance sheet from these programs is quite small (Figure 3). The MSLP has extended about $3 billion worth of credit to small- and medium-sized businesses, and the MLF's holdings are even lower at roughly $2 billion. The CCF has been a bit more active, but at only $13 billion to date, this is merely a drop in the bucket in the roughly $11 trillion corporate bond market.
Source: Federal Reserve Board and Wells Fargo Securities
So why hasn't take-up been more robust? To some extent, the programs' relatively small size reflects the fact that the economic outlook has improved since the spring when they were originally designed. Economic activity is steadily rebounding from its April low, and the unemployment rate has fallen to about 8%, roughly where it was in late 2012. Furthermore, financial market functioning and capital market access have improved, as spreads on municipal and corporate bonds have generally tightened and issuance is robust. To some extent, this is also just the nature of the Federal Reserve's role in economic policy; the Fed is the lender of last resort, and unlike Congress, the central bank cannot simply deliver mountains of cash with no strings attached. As the pandemic has worn on, companies and state and local governments may be thinking more about the long-run viability of their business and fiscal plans, rather than just their short-term access to credit and liquidity. This in turn could lead to a hesitancy to borrow, even at favorable rates.
As time has passed, the Federal Reserve has tweaked some of the terms of these facilities in order to help encourage more utilization. For example, the Fed extended MSLP loans out to five-year maturities, from four years previously, and it made principal payments deferrable up to two years instead of the previous one. And for the MLF, the Fed cut the interest rate spread on tax-exempt notes by 50 bps for each credit category. But, it does not appear these tweaks have been enough to encourage more broad-based take up.
We doubt the FOMC or the U.S. Treasury want to see the nation's central bank recklessly lending in a way that leads to credit misallocation and/or large losses for the Federal Reserve. That said, the $454 billion of financial firepower sitting on the sidelines has certainly been underutilized, and it seems unlikely to play a big role in the recovery anytime soon. Perhaps if FOMC members feel that the Fed's traditional options like quantitative easing are no longer effective, and if they continue to eschew other steps like negative rates or yield curve control, they could more materially ease the terms of the previously discussed lending programs. While it would be difficult to thread the needle, if done effectively, the Federal Reserve could help provide credit to segments of the economy that need it while also using the tools at its disposal to absorb some moderate credit losses currently occurring in the private sector.
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Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.
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