The Fed on Wednesday delivered a cautious take on the US economy and pledged ongoing support for the fledgling recovery.
“The coronavirus outbreak is causing tremendous human and economic hardship across the United States and around the world”, the statement reads. “[The Fed] is committed to using its full range of tools to support the US economy in this challenging time”.
A stunning upside surprise on the May jobs report appeared to show the US labor market is healing faster than anticipated, quirks and anomalies notwithstanding. The numbers added a touch of uncertainty to the June FOMC meeting, but the Fed’s tone suggests it will take more than one pleasantly upbeat top-tier data point to change the course of policy.
The figure illustrates a simple point: Things are a long way from “fixed”.
The Fed suspended economic forecasts in March given extreme uncertainty surrounding the pandemic. Fresh projections show the median assessment of the jobless rate at 9.3% this year, and declining thereafter (to 6.5% in 2021 and 5.5% in 2022). Note that this is essentially the Fed suggesting that unemployment has reset structurally higher, depending on your definition of “structural”. 5.5% in 2022 is much higher than the five-decade-low jobless rate that prevailed prior to the pandemic. That said, the long-run projection is still 4.1%, unchanged from December.
Inflation forecasts were slashed, as expected. The median PCE inflation forecast is just 1.7% by 2022.
Growth is expected to be horrendous this year. The median forecast from the Fed sees the economy contracting 6.5% in 2020 and recovering to expand 5% in 2021.
The new dots show no hikes out through 2022. The market was keen on any tweaks to the forward guidance which, headed into the June meeting, essentially just stated that rates will remain at zero until the committee judges that the pandemic panic has truly passed.
The new statement language isn’t much more specific in that regard. “The Committee expects to maintain [its] target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”, the Fed says.
Powell and co. will likely adopt yield-curve control at some point this year, but it won’t be now. A narrow majority of economists polled by Bloomberg see YCC coming to the US in September. The curve has steepened materially of late, and while that’s good for banks, long-end yields can’t be allowed to rise in disorderly fashion with the US on a borrowing spree to fund virus relief.
The press conference will be replete with questions (and hopefully answers) on the YCC issue and the potential timing of a rollout, although Powell with probably try to remain as coy as possible.
Crucially, markets were also looking for clues as to the pace of QE going forward. They have managed purchases on a weekly basis during the crisis, tapering daily Treasury buying to “just” $4 billion this week from as much as $75 billion at the height of the panic.
The Fed on Wednesday essentially announced a floor under the pace of purchases, promising to “increase holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace to sustain smooth market functioning”.
That means Treasury purchases will be at least $80 billion per month (MBS at $40 billion) and it also suggests the pace could be adjusted higher at any time. That optionality was a given, but markets will take note.
Large-scale repos will continue.
Although the economy still needs quite a bit of work, the corporate credit market is “fixed”, and you can take “fixed” both figuratively and literally.
Although actual purchases of credit ETFs under one of the central bank’s two corporate bond facilities are relatively small, the psychological effect on the market has been nothing short of astounding. Corporate issuance in 2020 is running at a blistering pace, spreads have tightened dramatically, and inflows to investment grade and high yield funds have approximated a tsunami since the Fed’s intervention turned the tide in late March and early April.
Stocks are also “fixed”. The S&P recouped the entirety of its losses for 2020 this week, and the Nasdaq 100 hit a fresh record high.
During the presser, Powell will likely be asked about moral hazard, risk asset bubbles and, importantly, whether the Fed is perpetuating inequality.
He’ll say the ends justify the means.
And he won’t be totally wrong.
The Fed’s hodgepodge of liquidity facilities and sundry emergency programs have largely succeeded in unfreezing key funding markets. That doesn’t get as much press as tightening corporate credit spreads (let alone gains on benchmark stock indexes), but perhaps it should.
Full June FOMC Statement
The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.
The coronavirus outbreak is causing tremendous human and economic hardship across the United States and around the world. The virus and the measures taken to protect public health have induced sharp declines in economic activity and a surge in job losses. Weaker demand and significantly lower oil prices are holding down consumer price inflation. Financial conditions have improved, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.
The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term. In light of these developments, the Committee decided to maintain the target range for the federal funds rate at 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.
The Committee will continue to monitor the implications of incoming information for the economic outlook, including information related to public health, as well as global developments and muted inflation pressures, and will use its tools and act as appropriate to support the economy. In determining the timing and size of future adjustments to the stance of monetary policy, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.
To support the flow of credit to households and businesses, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace to sustain smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. In addition, the Open Market Desk will continue to offer large-scale overnight and term repurchase agreement operations. The Committee will closely monitor developments and is prepared to adjust its plans as appropriate.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.
June dots
June projections
Ok. So, US equity markets will blast through all time highs and keep climbing. All aboard to infinity. I guess I’ll have to join the party. No, wait, we’ll see what comes out of the press conference. If I wait and miss 100 points on $SPX this afternoon, no biggie since it’s going to 4k, then 5k, then 6k, with nary a 10% correction anywhere in sight.
No, wait, $GOLD shot up. Maybe that’s better.
No, Wait. Bonds. The 10yr yield moved 7.5% today. Dang. I missed it.
It won’t be enough.
why is that?
The power of QE and zero bound and even negative rates diminishes over time. The Fed will have to accelerate its provision of liquidity to permit zombies to roll over what otherwise be non-performing debt. What are we going to do all sit around and watch Netflix and eat money provided by the Fed in lieu of popcorn. The Fed would be better off embracing MMT explicitly as a loss of confidence in fiat currency is a less dire threat than simply pouring money into the yawning maw of Charybdis that will simply become an unbearable burden leading to disorderly defaults and write downs.
What time frame are you referencing here
Well we are 12 years in –have you seen any signs of inflation? Labor force participation rates have actually declined because the Fed is fighting a larger force –demography. Every developed Western economy has an aging population which results in more dependents being supported by fewer workers. Productivity increases are necessary in order to make that sustainable. Productivity has barely increased since the GFC for two reasons 1) hard to raise productivity in a service based economy 2) Free money permits inefficient firms to persist and discourages innovation –low margin activity is a profitable enough activity to permit rent seekers to redistribute wealth. In short we have been doing this for over a decade, there were serious problems emerging in 2019 that have been obscured by Covid 19. Basically we were on an QE IV because the Fed was terrified of even the smallest slip back into a recession — a liquidity trap and spiraling deflation were real prospects and their money printing just is not enough to address the underlying fundamental structural problems facing developed economies –they are just permitting rent seekers to concentrate wealth which will only exacerbate these problems to the point where it will become a political not economic matter. The Fed should be advocating for A) Helicopter Money as Andrew Yang has proposed and explicitly embrace B) MMT despite my very deep misgivings about our ability to maintain faith in the “full faith and credit” These half measures will wind up making it worse –and we have had a long enough time series to conclude 4% GDP debt to generate 2% growth and no inflation is not a good use of money.
i didn’t see a timeframe in there
Not to say you’re wrong, but I’d point to Japan and say this can last a very long time
Japan is teetering on the brink of deflation as we write and that is a cliff that is very steep indeed. Japan’s savings rate is/was much much higher than the US’s. The US’s financing needs are greater, its status as the world’s reserve currency essential. Japan has been a free rider in a way that the US cannot replicate.
Agree to disagree. Japan’s debt to gdp is far worse and their status as a reserve currency not in danger despite much deeper japanification (sorry in advance for that one)
Japan is a net exporter to the US and in USD… US net importer since Reagan. Lots of pressure built up.
The yen is a haven currency not really a reserve currency and few global transactions are denominated in Yen compared with the USD, in which virtually every commodity is priced much to our benefit. Private savings rate in Japan is much higher than the US. Japan’s “post office” is teeming with yen making it effectively a collective mattress under which every Japanese widow has her life savings, which is considerable when calculating entitlements, stuffed. Abe has not repealed the recent taxes, despite their recessionary effect, to show the world Japan really can tax sufficiently to sustain its debt service. I am not running out and making a widow-maker trade anytime soon, but I disagree with the notion that Japan provides as good analog for the US as is generally assumed.
What would be a better analogue or are we in uncharted territory?
I think the US has a unique position in the world but I think the closest analog to me is the EU, but again it is imperfect as the ECB has much less central authority than the Fed and the regional imbalances within the bloc make coordinated efforts more challenging. However in terms of economic scale, maturity of economies, legal structures and banking systems it would seem closest to me.
On a completely different note: what really scares me –and it is really because it really scares Hank Paulson, is Chinese municipal finance. On a local level budgets holes were plugged by auctioning off real estate development rights and then using that income stream as collateral for municipal finance (I hesitate to say “bonds”). No really knows how much is out there –it is one of the darkest pool of all –or how the cash flow from the developers is. Have you seen the movie “The Producers” (I prefer the original with Zero Mostel and Gene Wilder)? because it might end something like that.
Is the extended open of the Open Market Desk any indication the Fed is braced for another storm? With indices above or at all time higns then why is this needed if not for the potential of a shock?