Last Wednesday’s Fed December meeting sent the USD lower across the board. As expected, the Fed expressed its dovishness and ruled out any possible rate hikes until at least 2024.
Quantitative Easing (QE) is a bond-buying program run by the Fed. Under such a program, the central bank buys bonds issued by the U.S. Treasury – basically buys the U.S. debt. In doing so, it lowers the yields and thus eases the financial conditions in the economy.
Such practice is part of unconventional monetary policy, and it is common when interest rates are at zero or close to the zero level. The more the central banks buy, and the longer the program runs, the more the monetary policy eases. With it, the currency.
What Did the Fed Suggest At Its December Meeting?
One of the most important messages that the Fed sent was that there is no end in sight for the QE program. Now that vaccines are rolled out, and somehow the world sees the light at the end of the tunnel, some voices suggested that the Fed should signal a possible tapering (i.e., slow down) in its bond-buying program as early as 2021. However, Chair Powell skillfully avoided any hint at such a thing.
So far, the Fed’s bond-buying program was tilted toward the shorter-maturity bonds. By doing so, the Fed managed to ease financial conditions in addition to lowering the federal funds rate to zero. Moving forward in 2021 and possibly beyond, the Fed suggested it may shift its buying toward longer-maturity bonds. Currently, the Fed buys $120 billion worth of bonds each month. To ease financial conditions, even more, it could increase the pace in 2021 or expand the duration of the program to 2022. Also, by shifting the target to longer-maturity bonds in a so-called ‘Operation Twist’, it aims at depressing the yields on the longer-term bonds. This way, corporations can issue longer-term debt at favourable conditions and invest the proceeds in the real economy.
However, there is not certain that the Fed will start the operation twist next year. When questioned, the Fed’s Chair Jerome Powell did not sound sure about the effectiveness of such a move. He even pointed out that some sectors, like the housing sector, bounced back quite strongly, but he did not rule out additional monthly purchases and even hinted that there is more that the Fed can do.