Powell Reads from His Script

The Federal Open Market Committee (FOMC) voted unanimously to hold rates steady in January as it weighs the stimulus provided by last year’s rate cuts against the emerging risks associated with the coronavirus. The spread of the virus via human-to-human contact outside of the U.S. is likely to prompt it to be declared a health emergency by the World Health Organization when it convenes an emergency meeting tomorrow. That means global disruptions to travel and supply chains, which will compound rapidly in the weeks to come.

The issue of coronavirus got the Federal Reserve’s attention because of the potential to roil China’s economy, now the second largest in the world, and the potential to disrupt global travel and supply chains. Much travel into China has been halted, while many factories at the epicenter of the outbreak - Hubei - have extended plant closings beyond the traditional downtime due to Lunar New Year celebrations. Travel and retail activity in China, which typically surges during the Lunar New Year, has already collapsed. Shopping malls in many parts of Asia are now dormant in response to the fear of infection.

The Fed changed very little in its statement regarding policy from the December meeting. One change that was notable was the language regarding inflation. The Fed committed to “returning” to 2% on inflation instead of “near” 2%. That underscores the fact that the Fed is not comfortable with inflation running below 2%. Chairman Jay Powell underscored at the last press conference in December that he would need to see a persistent overshoot on inflation, given the Fed’s symmetric target of 2%, before even considering raising rates again. The threshold to cut rates is much lower than the threshold to raise rates. Just as risks of a trade war are dissipating, disruptions due to the coronavirus are emerging.

Powell took a victory lap in that the Fed’s interventions in the overnight credit market helped to avert another spike in overnight rates at year-end. He also underscored that the Fed is going to continue purchasing Treasury bills to keep reserves at an “ample level” - above $1.5 trillion. Powell said he expects they will reach an “ample level” in the second quarter (after the April tax season is complete). The hope is to reduce purchases then, but Powell was cautious to say the Fed will remain flexible in its purchases. Powell continues to argue that the expansion of the Fed’s balance sheet is not a form of quantitative easing (QE) but the Fed is aware that many market participants disagree and see any expansion in the balance sheet as QE. Powell is still clearly struggling with how to communicate the Fed’s next move, which he has until the meeting in March to figure out. Powell was careful not to reveal too much on this topic for fear of unintentionally roiling financial markets.

It remains unclear that the Fed knows what actually happened last September when overnight lending rates surged, which is disconcerting. If Fed officials don’t know what went wrong, it is unclear it has been fixed.

When asked about the labor market, Powell was positive that low-wage earners are finally getting raises. The Fed is still willing to allow unemployment to fall if that triggers more heat in wages and eventually inflation. This is an area where the Fed has shown humility, a rare event.

Bottom Line
Powell has become much more scripted. He read directly from his notes when asked questions about the potential impact of the coronavirus, the overnight repurchase market and when he went on at length about prospects for a global rebound. The coronavirus may derail those hopes. We are sticking to our forecast that the Fed will cut at least once in 2020 to sustain the expansion.

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