Markets Need Clarification

The Federal Open Market Committee (FOMC) concluded a two-day meeting with only a few notable changes in its official statement. Committee members were careful to underscore the weakness in employment since the last meeting in mid-December. Losses were largest in the leisure and hospitality sector. Layoffs at restaurants and bars more than accounted for the weakness that we saw in December. Fed Chairman Jay Powell emphasized the size of those losses several times. He appeared to be somewhat relieved that the economy has been able to grow, outside of the most COVID-sensitive sectors.

The most recent unemployment claims data suggest that losses may have spread to more sectors. Layoffs in the manufacturing and construction sectors appear to have increased. That would be unwelcome news for the Fed. Powell spent a lot of time talking about the resilience of employment in sectors where we can work from home and the outsize role technology has played in keeping spending going. He noted that people are now buying homes online, without even entering them. He also noted the role that technology has played in automating some jobs, which could leave more workers permanently behind.

Powell was asked about the removal of references to the timeline on the risks we face. The resurgence in COVID cases, resulting damage to the economy and the dependence on the pace of vaccinations have shifted downside risks from the future to now.

The statement added an important clarification to the mantra that “[t]he path of the economy will depend significantly on the course of the virus.” It amended that sentence to include “progress on vaccinations,” which will ultimately determine when and if herd immunity can be achieved. Powell spent a lot of time explaining just how really tragic and significant current losses to the economy remain. He noted that employment losses are as large as they were during the height of the financial crisis, a year after the onset of the pandemic. (The numerical losses are actually greater than they were during the height of the financial crisis.)

Powell pointed out that job losses are much more uneven than in the past. He is clearly worried about the workers hit hardest by the crisis, women and people of color, and how quickly and whether they can be re-employed. He did something that I have never seen a Fed Chairman do: talk about the actual unemployment rate, which is closer to 10% instead of the 6.7% reported by the Bureau of Labor Statistics. That is what you get once you include those who are not officially classified as “unemployed,” but have been displaced by the crisis. (Many women have dropped out of the labor force to take care of children who are learning online instead of in schools. The participation rate for women in the labor force is back at levels not seen since the 1980s, when baby boomers were still joining the labor force en masse.)

Reading between the lines, the FOMC members appear to be slightly less confident than they were in mid-December. The mutations of the virus, which make it more contagious and potentially more lethal, are worrisome. Those shifts have already prompted more aggressive lockdowns abroad and could undermine the efficacy of the vaccine itself. We are in a race to get as many people vaccinated as possible before the more contagious variants of the virus take over. We need to win that race or face an even larger setback in economic activity. Powell admitted as much when asked about the change in the statement to include the pace of vaccinations.

The FOMC reaffirmed its stance on both keeping short-term interest rates near zero and its balance sheet purchases at the current $120 billion in Treasury bond and mortgage-backed security purchases each month. Powell went a step further in his remarks and argued that there are no clear, set numerical rules in place when it comes to raising rates or slowing the pace of balance sheet purchases. He admitted that there is no way of making explicit decision rules given the uncertainty we face. That is important as it means that we will continue to hear a spectrum of views on that from members of the FOMC. We shouldn’t put too much weight on that dissonance; Powell said he will let us know when the Fed is ready to consider a change in policy.

This is going to be an ongoing struggle for the Fed on messaging. Some would like to exit crisis-era policies sooner than others, which has prompted concern about another taper tantrum on Wall Street. [Former Fed Chairman Ben Bernanke inadvertently triggered a sharp increase in long-term bond yields when he mentioned the Fed was considering slowing the pace of its purchases in May 2013 during testimony to Congress.]

Jay Powell is well aware of the dangers of that happening and has essentially told us he does not want that to happen. That is as far as he can go, given the need to be flexible on policy and the wide uncertainty bands we are dealing with. Powell is refreshingly humble on this front. He is willing to state openly what he doesn’t know. Historically, Fed chairs were more confident about their forecasting prowess.

Powell shrugged off risks of a flare in inflation, given the one-two punch of accomodative monetary and fiscal policy. Inflation has been on a multi-decade downtrend, which is harder to counter than an surge in inflation. The Fed has the tools to counter a flare in inflation: It could raise rates. Frankly, that would be a problem it would welcome, as it would suggest that the economy has healed much more rapidly than they hoped.

Powell was also questioned about asset price bubbles. He discounted the link between low interest rates and asset prices. This is where Powell the Artful Dodger reemerged. He argued that many things affect asset prices besides interest rates. He also said the link between “asset prices and low interest rates may not be as tight as some think.” I can’t say I fully agree but understand that he feels he has his hands tied. He can’t risk raising rates to fight an asset price bubble given the blow that could deal an economy that is now losing ground again. He was remarkably confident about the financial stability of banks. He also singled out the low pace of corporate debt defaults. “Good companies have been able to finance themselves.”

That is true until it isn’t. Financial crises have a habit of hitting us quickly, but current members of the FOMC have made it clear they are not willing to do much to stem those risks now. The Fed has said that it would rely on its regulatory authority to require higher capital buffers, fees, etc. - if risks arise.

Bottom Line
The Fed doubled down on its concerns that the virus will take more of a toll on the economy. Powell stressed the need to rapidly increase the pace of vaccinations; that is what is needed to reopen the economy more fully and begin the process of healing.

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