The Federal Reserve will likely lean on its massive asset purchases to absorb the economic shock of surging coronavirus cases. But instead of immediately ramping up its quantitative easing program, the Fed may opt to use its words — by signaling how it could adjust its asset buys.

The central bank will kick off its final policy-setting meeting of 2020 on Tuesday, with the Federal Open Market Committee’s statement due Wednesday afternoon.

In that announcement, the Fed is expected to offer forward guidance pinning the Fed’s purchases of mortgage-backed securities and U.S. Treasuries to the development of economic conditions. But for the meantime, the Fed would hold steady on its $120 billion-a-month pace of MBS and U.S. Treasury purchases.

Adopting so-called “qualitative outcome-based guidance” would allow the Fed to say it would not taper off its asset purchases for a while, assuring markets that the monetary stimulus will continue for some time.

Fed officials already appear set on offering such guidance.

Minutes from the Fed’s November meeting note that “most participants” on the FOMC supported a commitment to expanding its balance sheet until the U.S. economy appears close to the Fed’s dual mandate goals of maximum employment and stable prices.

San Francisco Fed President Mary Daly told reporters on December 1 that stronger guidance on QE is “just the next natural step for providing clarity to market participants and household businesses about what our plans are.”

Richmond Fed President Thomas Barkin had told Yahoo Finance on November 18 that the Fed could “do something different and more” if needed.

Deutsche Bank Research noted December 10 that the Fed’s phrasing on QE guidance will “speak louder than actions.”

How much guidance is too much?

Wall Street economists say such a commitment would give the Fed flexibility with its monetary policy. With downside risks from the rising case count but upside risks from the vaccine, the Fed’s verbal promise would offer support without the need to immediately beef up its asset purchases.

But how will the Fed square QE guidance with its existing guidance on near-zero interest rates?

As of November, the Fed’s guidance on rates was to keep interest rates at rock bottom until the economy appears to be at maximum employment with inflation at 2% and “on track to moderately exceed” that target “for some time.”

The most recent reading of the Fed’s preferred measure of inflation (year-over-year changes in core personal consumption expenditures) was well short of that goal: just 1.4% in the month of October.

Bank of America’s global research team wrote December 11 that the Fed will have to “do some gymnastics with the language,” expecting the central bank to vaguely commit to not tapering asset purchases “until sufficient progress has been made to ensure that inflation” hits its 2% target over the long run.

Wells Fargo similarly expects that the Fed will want to carefully craft its words to leave room for flexibility with its balance sheet policies. The bank’s economics group wrote that the Fed may want to keep its powder dry for use in the future, at which point it could decide if the economy needs longer-dated asset buys (targeting longer-term Treasury yields, for example) or larger purchases in aggregate.

“The impact of any adjustments in the Fed’s asset purchase program at this stage would likely be limited,” Wells Fargo wrote on December 7.

Other things to watch for:

• Fresh round of “dot plots.” The Summary of Economic Projections (SEP), released quarterly, will map out policymakers’ expectations for where the federal funds rate will be at the end of 2023. For comparison, the median FOMC participant in September saw interest rates remaining near-zero, with only four policymakers seeing the case for at least one raise by then.

• New charts in the SEP. Beginning with Wednesday’s meeting, the Fed will release charts that detail policymakers’ views on uncertainty and risk facing key economic readings like real GDP, unemployment, and inflation. The new charts will help Fed watchers understand the degree of confidence by which the Fed forecasters map out the trajectory of the economy.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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