NEW YORK (Reuters Breakingviews) - Federal Reserve Chair Jerome Powell has been too effective. His pledge to purchase corporate debt, including some with a junk credit rating, has boosted bond and equity prices since March, despite lousy economic projections. Backstopping asset prices is the unspoken precept that underlies the new policy framework he will soon unveil.
Powell may well preview the outcome of the Fed’s policy review when he speaks on Thursday at the Kansas City Fed’s annual conference, which has moved from scenic Jackson Hole, Wyoming to the internet. One option is switching to average-inflation targeting. So inflation could run higher than 2% if the goal has been undershot for years. The Fed chair might also adopt so-called forward guidance that links policy more explicitly to economic data by saying, for example, interest rates will be kept near zero until inflation or unemployment hits a certain level.
But a more radical shift has already occurred. The additional yield that an index of U.S. bonds rated CCC and lower – super junky debt – offers over safe U.S. government debt has shrunk by more than a third since late March. Yet S&P Global Ratings forecasts the high-yield corporate default rate will be 12.5% by March 2021 – a 350% jump from the previous year. Investors are behaving as if the Fed won’t let asset prices fall.
There's good reason. The Fed raised rates more than other major central banks after 2008 but eased policy three times in 2019, apparently spooked by a 2018 equity market sell-off and growing trade tensions. And the lending facilities unveiled to fight the 2020 crisis – especially one to buy junk debt – seem to have reduced investors’ concerns about credit default risk, not just liquidity.
Powell has been cagey about asset prices. If he explicitly says the Fed won’t backstop markets, he would have to stand by if equity markets slumped. It’s unlikely he will do this when the jobless rate is above 10% even though the link between stock prices and the economy is not particularly strong right now.
Adjustments to the Fed’s policy framework are important. But the bigger change – the central bank’s unspoken, yet obviously heightened, concern about upsetting asset markets – occurred in the past decade without any official fanfare.
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