Fed Stays the Course

The Federal Open Market Committee (FOMC) is scheduled to meet on June 9-10. The Fed is not expected to move any further on interest rate policy at this time although it is getting close to launching the Main Street program, which will garner attention at the press conference that follows the meeting. Skepticism regarding the ability of the Fed to lend directly to middle-market companies and nonprofits (largely universities) is high. A similar program failed miserably during the Great Depression.

The Fed is expected to stand pat on rates and policy but will have to acknowledge the extraordinary economic costs associated with COVID-19 and the uncertainty surrounding the rebound in growth in its statement following the decision. The Fed will welcome the improvement in employment we saw in May but those gains will not be enough to stop members of the FOMC from worrying about the pace of the rebound in growth. The Fed has been consistent in its view that more fiscal stimulus will be needed. It is not expected to back down now.

There is no way to know when and how many businesses can safely reopen while maintaining social distancing and preserving the safety of their workers and customers. The uneven pace of reopening across the world and in the U.S. further complicates the outlook because disruptions to supply chains within and outside the U.S. are likely to persist. Social unrest will also have to be addressed as a downside risk to the near-term outlook, given the dampening effects it is likely to have on efforts to reopen and risks of increased contagion.

The Fed has said that it will bring back its infamous “dot plots” for this meeting. Look for all FOMC participants to keep their forecast for the fed funds rate near zero through 2023. No one on the Fed is willing to currently consider negative rates to counter the effects of COVID-19 on the economy. Also, look for the FOMC to reduce long-term estimates for potential growth, inflation and what members consider the neutral fed funds rate. COVID-19 is expected to deal a blow to the forecast for potential growth as it is exacerbating the contraction in business investment that took hold in response to trade wars last year.

Near-term forecasts for growth and unemployment will vary fairly dramatically. The largest outlier is expected to be St. Louis Fed President Jim Bullard, who has been consistently more optimistic than his colleagues on the prospects for a rebound, although he has not argued for rate hikes.

The Fed is weighing whether to shore up its forward guidance on rates, i.e., promising low rates for longer and tied specific targets for employment and inflation. It would be useful to announce that with the resumption of the dot plots, but the Fed would like to keep its powder dry on forward guidance for now. The Fed is considering yield curve control down the road and is looking closely at Australia's success in targeting specific government bond yields. We are expecting a downdraft in inflation to prompt the Fed to actively engage in yield curve control near the turn of the year. Deflation remains a threat in the near term.

Another issue that is likely to come up is the buoyancy of the stock market. The Fed has begun to flag the downside risk to bank balance sheets associated with a surge in bankruptcies tied to COVID-19. Look for Chairman Jay Powell to emphasize that the Fed is doing what it can to support credit markets, not the broader stock market. This is a hard line for the Fed to walk. Financial markets are clearly betting that the Fed can do more to save the economy from additional setbacks. Powell will continue to argue that more fiscal relief from Congress is what is really needed.

Bottom Line
The Fed would like to make no news at the conclusion of its meeting on Wednesday. That will be tough given the pace of change we are facing and the weight financial markets have placed on the Fed to save them from all that ails us.

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