Fed leaves rates unchanged

Yahoo Finance’s Alexis Christoforous, Brian Cheung and Adam Shapiro discuss the Fed’s decision to leave rates unchanged.

Video Transcript

ALEXIS CHRISTOFOROUS: Hello, everyone, and welcome to Fed day on "Yahoo Finance Live" for this Wednesday, December 16. I'm Alexis Christoforous along with my colleague Adam Shapiro. The Federal Reserve just wrapped up its final meeting of the year. We are moments away from the central bank's decision on monetary policy.

Here's a check of the markets for you as we wait for that decision. By the way, investors digesting a disappointing November retail sales report today which showed a sharp drop in consumer spending for the second consecutive month. We've got the Dow Industrials off 72 points. The S&P up about three. We've got the NASDAQ composite at a record high of about 45 points now along with the Russell 2000, by the way. That small-cap index hitting another record high.

Want to check in with Adam Shapiro now. Adam, what are investors hoping to hear from the Fed today?

ADAM SHAPIRO: Well, a matter of hope. They want some direction as to the duration of the Fed's bond-buying program, or are they just going to communicate the future direction of that, things like 10-year or 30-year bonds? Alexis.

ALEXIS CHRISTOFOROUS: All right, we are getting that decision from the Federal Reserve right now. Again, it is the final Fed decision of 2020. We've got our correspondent Brian Cheung joining us now with the statement. Brian.

BRIAN CHEUNG: Hi, Alexis. Well, the Federal Reserve holding interest rates steady at near zero. No surprise there. But new language from the Federal Reserve committing to keeping its aggressive quantitative easing-- again, its pace of asset purchases-- at the current levels-- at least the current levels, quote, "until substantial further progress has been made toward the committee's maximum-employment and price-stability goals," end quote. I'm reading that from the statement that, again, was just released by the Federal Reserve.

This is the new language that people had expected. This is the new forward guidance that now pins the Federal Reserve's quantitative easing program.

Another way of reading that for those that aren't aware of the Fed speak is the Fed will not be tapering its asset purchases until it finds that it's pretty close to maximum employment, which could mean that 3.5% pre-COVID level of unemployment in addition to, obviously, inflation that's moderately above its 2% target, which we're also a ways away from.

So this is kind of falling in line with the Federal Reserve's guidance at least on interest-rate policy, which based on the dot-plot projections that were released alongside this report, would actually stay near zero through the end of at least 2023.

A few other things to unpack in this particular release. We have to take a look at the dot-plot projections, obviously. This is something that comes out quarterly that shows where the Federal Reserve could see interest-rate policy in addition to economic indicators going in the next few years.

One notable difference is that it appears there's a slightly rosier forecast on where we might see the end of 2021. Obviously we're wrapping up 2020, but when you look at the unemployment rate, for example, we see that the unemployment rate is now being projected by the median FOMC member to end 2021 at 5%. That's much better than the 5.5% that the median member of the committee had projected back in September the last time we got this released.

The same is also true for economic output. So take a look at real GDP, for example. When you unpack the projections now, the median member of the FOMC sees the US economy growing by 4.2% in 2021 compared to just 4.0 as projected in September.

Now on the other side of things, you take a look at inflation, for example. The Federal Reserve saying that inflation could be 1.8% in terms of core personal consumption expenditures in 2021. That's a notch higher than the 1.7% it had projected in the September meeting.

So a lot of moving parts there. Some of that could be due to the vaccine developments. It's important to know also that this FOMC was going concurrently during the talks of fiscal stimulus down in DC, so can't really tie any sort of developments on that front to the report that's being released today.

And then one last point that's worth mentioning-- this was a unanimous decision. No one dissented against the FOMC statement wording that was just released. So any sort of new changes, again, might be kind of clarified in the press conference from the Fed chairman Jay Powell in about 28 minutes or so.

But really, that was the only change in the statement itself, that language on quantitative easing of what it's going to do with that going forward. Everything else, Alexis and Adam, was exactly the same.

ALEXIS CHRISTOFOROUS: So Brian, the Fed here committing to keeping-- to keep buying bonds until the economy gets back to full employment. Was this message dovish enough, do you think, to meet investor expectations?

BRIAN CHEUNG: Well, I think, a real tell of all this is going to be what's happening in the bond market. So because the Federal Reserve's quantitative-easing program primarily concerned snatching up US Treasurys, what we see from the bond market could be very telling for what's going to-- what the market reaction is going to be, whether it was dovish enough of a statement.

Now, of course no one really expected that many material changes in the wording of the statement that was just released three minutes ago. If anything, it's possible that the bond market and investors are still waiting, at least for the next 27 minutes before the Fed chairman gets to the podium virtually, of course, and addresses questions about how the Federal Reserve could change its quantitative-easing program going forward.

The statement only says it's going to maintain at least the current pace of $120 billion a month in asset purchases-- $80 billion of that in US Treasurys spread out across the maturities in addition to $40 billion of agency mortgage-backed securities. So Fed Chairman Powell will probably face a question in about 26 minutes or so that say, hey, if you were to adjust those asset purchases if conditions deteriorate more, we know that that $120 billion is going to be the floor. So would you increase those aggregate purchases, or would you keep that same amount of clip of those asset purchases and simply twist the way that you're targeting those purchases-- for example, targeting more longer-dated securities and subbing in, for example, 10-year or 30-year purchases as opposed to maybe one- or two-year Treasurys?

So that could be something that's definitely in focus. But again, that color would not come from the statement that we just saw. That would come in the press conference due in a few minutes.

ADAM SHAPIRO: Do you expect, Brian, that Powell would address that directly, though, if they would change the duration of that which they're buying?

BRIAN CHEUNG: Well, I think, if anything, the Fed chairman would do what he's been saying for the past few meetings and in congressional testimony as well, which is that the Fed still has ammo. So he might keep his cards close to the chest by saying there are things that we could do but then not hint at exactly how he wants to address that.

Now, one major question is at what level would longer-term interest rates be high enough that would warrant the Federal Reserve to say, you know what? I think we need to step in here and target more longer-dated purchases to try to depress those borrowing costs to stimulate more consumption in the present?

Now, what we know is that so far US Treasury, at least on the 10-year, has been flirting with that 100-basis-point level. It hasn't quite gotten there yet. I'm looking at it right now. I think it's about 91 basis points-- or sorry, not 91 basis points, but it's at about-- let's see-- 94 basis points right now, so not necessarily too close to 100-basis-point level.

Would the Federal Reserve be concerned if it did reach that psychological level or maybe more than that, 105, 110 basis points? The Federal Reserve is definitely going to be watching that. But as far as the press conference today, I think the Federal Reserve would likely keep it quite broad and not speak the specifics of how it might change it in the future, just really leave those options on the table.

ALEXIS CHRISTOFOROUS: Well, I know, Brian, you've got to run off now to be part of that press conference. Get your question ready there for Chairman Jay Powell. So thank you very much.