Fed Cautious About Rebound During COVID

The Federal Open Market Committee (FOMC) voted unanimously to hold short-term interest rates at close to zero at the conclusion of the meeting today. FOMC members also decided to provide more support for the mortgage and Treasury bond markets. They committed to continue to buy, per month, at least $80 billion in Treasury bonds, $40 billion in mortgage-backed securities and up to $2 billion in commercial mortgage-backed securities. This is critical as the Treasury bond market and mortgage market are functioning better, but not perfectly after the meltdown in financial markets we saw in late March.

The Federal Reserve also released forecasts for the economy. The Fed expects to see a sharper downturn and a slower recovery compared to many private sector forecasters. The Fed assumptions do not include additional fiscal relief. Chairman Jay Powell once again stressed the need for Congress to step up in response to COVID losses. (Congress needs to do more.)

The Fed’s forecasts show near-zero interest rates continuing indefinitely. They also show inflation below its 2% target for the foreseeable future. The Fed clearly sees COVID as more deflationary than inflationary, despite the near-term shock to the food supply. The Fed did not lower estimates for long-term growth or long-term unemployment on the premise that the Fed and the government will do all they can to keep enough businesses, nonprofits and households afloat over the long term to avoid permanent damage to the economy. This is still more of a wish than a reality; Powell underscored that he hoped he would not have to change that outlook.

Powell is open to using other tools: more aggressive forward guidance and yield curve controls, should the economy need more support from the Fed down the road. We expect the Fed to be more specific in the commitment to hold rates down tied to data targets for inflation and unemployment. We also see the Fed trying to set a cap on Treasury bond yields by year-end.

Powell was careful to underscore the extraordinary level of uncertainty regarding the pace of reopening. He noted that the ideal for the economy would be if infections could be brought under control during the summer. The goal is to reassure consumers that it is safe to return to public places. Infections are rising again in many states, which could undermine the pace of the recovery. Powell argued it is “self evident” that recurring regional outbreaks could slow the pace of the recovery.

He stayed away from specific advice on additional fiscal policy measures but left the door open to providing Federal Reserve analysis to members of Congress, if requested. The Fed has expanded its research capacity to look at ways to foster more equitable growth, despite the clear limits of monetary policy. Powell repeated his mantra that the Fed can lend, but not spend.

The challenges we face require our elected officials to step up and deliver on spending and investing to level the playing field.

The Fed has yet to launch its Main Street lending facility. Powell did little more than assure his audience that it will be open soon. There is a lot of skepticism about its success. Similar facilities failed during the Great Depression. Powell seemed more reassured about the impact of the announcement of these lending facilities for firms seeking credit.

Powell said a lesson of the expansion was that inflation did not pick up as expected when unemployment plummeted. That opens the door to keeping unemployment lower for longer without raising rates. The only tool the Fed has to directly lift the fortunes of the most vulnerable workers is to extend the duration of the expansion.

Powell dodged a direct question on the break between the performance of equity prices and the broader economy. Powell argued that he can’t target policy to equity levels.

Bottom Line
The Federal Reserve remains extremely cautious about the pace of the rebound. Members of the FOMC remain more concerned about downside risks, including disinflation, more than upside risks. And, Congress needs to step up.

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