FOMC, QE and the Overton window

The Dow Jones took a short breather today shedding 44 points from its levels yesterday. This was on a day which was punctuated by FOMC, Fed Chief’s Jerome Powell’s press conference and slight progress on the pandemic relief bill in the US Congress. The Dollar Index is trading at 90.14 currently which is its lowest since April 2018, the US 10 year yield is at 0.93% and Brent crude is trading at 51$/bbl, its highest since March.

Having checked the market parameters, let us come back to the important news of the day which was the FOMC. The FOMC kept the size and tenor of the bond purchase the same as in the previous meetings but committed that it will keep buying the bonds until “substantial progress has been made towards the committee’s maximum employment and price stability goals”. The FOMC in a statement added that “the asset purchases help foster smooth market functioning and accommodative financial conditions and ensure flow of credit.” Essentially this is QE ad infinitum.

In his book Overdraft, Ex RBI Governor Urijit Patel introduces his readers to a concept called the Overton window. The concept basically is that any idea which starts as a radical one initially becomes normal owing to gradual shifts over time and anyone watching feels that it was the most normal one to start with. Though he uses it in a completely different context of discourse about the Indian political economy, we would try to fit it to the FOMC and its QE programs. 12 years back, during the GFC crisis when the interest rates were slashed to zero and the US Fed embarked on its first QE buying mortgage backed securities (MBS), the idea of directly buying debt was hotly debated and was considered a primal sin by the conservatives. But over a period of time, the idea’s Overton window expanded and it became the mainstream thought. There is no limit to how big the Fed balance sheet can be. Now when the US Congress ultimately passes the second relief bill it knows that the bonds can be bought by the Fed. The erstwhile concepts of balancing the spending with tax raises is gone. The whole classic money supply and inflation equation is also nowhere to be seen (at least in the developed world).

Readers would note that buying bonds by the Central banks provides cash into the banking system, which they then are expected to lend out. However there is no fiat to make them lend and only the guiding signals like LTRO’s and TLTRO’s can be provided by the central banks. In the absence of good risk adjusted lending prospects incountry this money soon goes offshore and gets invested into a variety of assets including emerging market equities and commodities. Copper prices in LME have moved from 4800$/tonne (end March) to 7800$/tonne now.