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Powell Walks the Line

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The Federal Open Market Committee (FOMC) is scheduled to meet on December 15 and 16. At the conclusion of that meeting, the FOMC is expected to provide guidance regarding what might prompt it to further expand the Federal Reserve’s asset purchases program. The Fed is now buying an additional $120 billion per month: $80 billion in Treasury bonds and $40 billion in mortgage-backed securities. The Fed reinstated the asset purchase program to stop the meltdown in credit markets in March, which threatened to eclipse that of the global financial crisis in 2008-09.

Several members of the Federal Reserve’s Board of Governors in Washington and regional Federal Reserve Bank presidents have made it clear that the Fed will continue to purchase “at least” $120 billion a month for now. They have also signaled a desire to clarify what would cause them to increase and potentially lengthen the maturity of the Treasury bonds they buy.

However, and this is key, the Fed has been united in the view that no additional purchases are needed at the moment. Those who are betting that the Fed will take action to actually further expand the controversial asset purchase program on December 16 are likely to be disappointed. Instead, the FOMC will lay out the guidelines that need to be met to warrant increasing the pace of asset purchases. Officials will only increase asset purchases if credit markets hit another roadblock and begin to seize; also, they are likely to signal they will keep those purchases in place until the economy is well beyond the current crisis.

Much will depend upon whether Congress can come to a deal on additional fiscal relief before the year-end. The breakdown in talks is a national embarrassment, given what is at stake. The federal government could be forced to close, while more than 13 million gig, furloughed, self-employed and workers who have now applied for extensions to unemployment insurance (UI) benefits will lose all support. Millions will be forced onto the streets when eviction moratoriums are lifted, which will exacerbate the pace of contagion.

The breakdown in negotiations also threatens to roil financial markets. That would force the Fed to act sooner. The Fed has no choice but to intervene if credit markets seize. Otherwise the COVID recession could morph into an even worse financial crisis.

The FOMC will also provide the usual quarterly forecasts for growth, unemployment, inflation and interest rates at the December meeting. Look for the Fed to upgrade its estimate of growth for 2020, despite the recent resurgence in COVID cases. Risks will remain to the downside in the near term. The fear is that the recovery could stall or worse over the next several months. The surge in cases and hospitalizations is overwhelming the health care system; the care of COVID and non-COVID patients is being compromised. That forces states to make tough decisions on tightening containment measures.

Federal Reserve Chairman Jay Powell will have to walk a narrow line. He will be tempering the Fed’s optimism on a vaccine and an end date for the crisis with the reality of the additional losses we will endure before we get there. He will reiterate support for a relief package and fears that the wounds inflicted by COVID could leave deep scars on the complexion of our labor market and exacerbate inequality. Less even growth deals a blow to our potential to grow even after the crisis has abated.

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