Fed View: Technical cut to IOER looks warranted, but tricky – The effective fed funds rate has crept higher over the past month, rising to 2.44% this week, having been largely stable at 2.40% since the most recent rate hike in December. Typically, the Fed aims to keep the fed funds rate close to the midpoint of its target range (currently 2.25-2.50%). The Fed already made two technical adjustments to the IOER in June and December last year to better anchor the fed funds rate in the middle of the range, following periods where it traded uncomfortably close to the upper bound. The issue has been an ongoing topic of discussion on the FOMC, and meeting minutes from November showed the committee even considering an intermeeting cut to the IOER as a contingency plan, if the fed funds rate were to continue to drift higher.
Given how close the fed funds rate is now to the upper bound, a further technical adjustment to the IOER looks warranted – potentially as soon as next Wednesday’s FOMC. This would likely take the form of a cut to the IOER from 2.40% to 2.35%. However, communicating such a move to markets and the public would be a challenge. Previously, the Fed has managed IOER adjustments not by cutting the IOER, but raising it by less than its hike of the target range for the fed funds rate (i.e. it raised the IOER by 20bp in June and December last year, instead of 25bp for the fed funds target range). Should the Fed make such a move, it would no doubt stress to markets that the adjustment is entirely technical, and does not represent an easing of monetary policy. Indeed, given the recent pressure from President Trump, who has openly called for rate cuts, the communication challenge is even more crucial for the Fed to maintain its credibility. (Bill Diviney)
ECB View: De Guindos suggests QE is the instrument of choice – ECB Vice President Luis de Guindos made a rather cautious case for an improvement in the eurozone economy later in the year, saying ‘some of the forces that were behind the deceleration that we started to experience in 2018 will start to go away’. He underlined that ‘financial conditions are very easy. The evolution of the labour market is positive. Consumers are in a much better mood than they were only a few years ago’. However, he qualified these comments by saying that he could not be ‘super optimistic’. He also discussed the macro policy response to the slowdown. On fiscal policy, he said that the German authorities had ‘fiscal space to face up to a deceleration’. On monetary policy, he seemed to suggest that the next step for the ECB – if further monetary stimulus was needed – would be QE rather than rate cuts. He said that asset purchases were ‘something we can use again if needed, if we see that our mandate is not going to be accomplished’. This implies the central bank is willing to raise the issue(r) limit to above 33%, as this would be necessary to execute a further significant round of sovereign bond purchases. In addition, he signalled that the conditions on TLTRO-III would be similar to those of TLTRO-II. This means that banks could enjoy borrowing rates as low as -0.4% if they meet certain lending benchmarks. Finally, he did not sound too concerned about the impact of negative rates on the banking system, which probably means he is not in favour of introducing a tiered deposit rate system at this stage. He noted that low interest rates are ‘not the reason of the low level of profitability of the European banks. The low profitability of the European banks has to do with structural factors. For instance, excess capacity’. (Nick Kounis)