The surge in US coronavirus cases is pushing the Federal Reserve closer to a delicate decision on the best way to deliver more monetary support to the US economy, but the central bank is unlikely to move imminently.
Policymakers will gather for a meeting of the Federal Open Market Committee on Tuesday and Wednesday that will be dominated by the threat to recovery posed by the spread of Covid-19, including in such economically vital states as California, Texas and Florida.
The darkening picture will increase the Fed’s impetus to take additional action to reassure investors of its commitment to ultra-easy monetary policy, most likely in the form of a firmer pledge to keep US interest rates low until certain economic milestones are reached.
“It looks like the economy is levelling off,” said Gene Tannuzzo, deputy global head of fixed income at Columbia Threadneedle. “The Fed will have to do something more, but the challenge is . . . where they can apply their tools to be economically effective.”
The main reason why they don’t seem to be in a hurry is that markets are giving them some leeway
With financial market conditions remaining relatively strong, the Fed has signalled it is leaning against any announcement this week. This would give it more time get a firmer grasp on the data, and reach an internal consensus on its next move. Many Fed watchers are betting that a shift will not happen until at least the September meeting of the FOMC.
“One of the reasons they are not yet ready to pull the trigger is they need more space to be able to figure out what they’re aiming at,” said Randall Kroszner, a former Fed governor and economist at the University of Chicago. “In particular, there’s an enormous amount of uncertainty about the virus, about the responses to the virus, whether that’s on the fiscal side or on the health side, and uncertainty about the economic consequences.”
Ellen Zentner, a senior US economist at Morgan Stanley, said: “The uncertainty around the outlook has been sizeable and continues to be sizeable. But at this stage, the FOMC cannot necessarily already determine that the policy accommodation it has put in place is not enough.”
Since Covid-19 reached the US, the Fed has slashed interest rates close to zero, expanded its balance sheet through open-ended asset purchases, and set up credit facilities to shore up the financial system. Throughout the crisis the Fed has been dovish, maintaining it would keep interest rates low until it was confident that the US economy had recovered and was prepared to use its “full range of tools” to limit the damage.
“It’s too early to do more, but the last meeting was in early June and things have turned 180 degrees since then,” said Win Thin, head of currency strategy at Brown Brothers Harriman. “They have to acknowledge the worse outlook.”
Jay Powell, the Fed chairman, has a ruled out negative rates for the time being, leaving more aggressive “forward guidance” as its most likely next step. Charles Evans, the president of the Chicago Fed, said this month such a move would have the benefit of “convincing . . . people in the markets and the public that we’re really in it to win it”.
Senior Fed officials including Lael Brainard have suggested a consensus might be forming around a pledge to not tighten policy until inflation reaches its 2 per cent target. The Fed has come around to the belief that the coronavirus shock is disinflationary because of the drop in demand, rather than a supply-side hit that could bring shortages and drive up prices.
Another option being discussed within the Fed is to link the next rate increase to a certain level of unemployment, to guarantee that the labour market would be in sound shape before any tightening.
The change could present some pitfalls, particularly if investors perceive the new benchmarks to be confusing or ill-suited to crisis. Such concerns could unsettle financial markets, which would add to the Fed’s caution in refining the language of new guidance.
“Our view has been that ultimately they will converge to a double criteria, where core PCE [inflation] has to be at 2 per cent year-on-year and the unemployment rate has to be low,” said Jan Hatzius, a senior economist at Goldman Sachs. “The main reason why they don’t seem to be in a hurry is that markets are giving them some leeway . . . If there was some kind of tantrum, then obviously they’d be under a lot more pressure to move. But there isn’t.”
John Williams, the president of the New York Fed, suggested the central bank felt it still had room for manoeuvre before acting. The central bank’s current language on policy was “serving us well”, he said, adding that the Fed had “some time to think about how we should evolve that guidance as we go forward”.
The central bank is not expected to make big changes to its asset purchase policies. The Fed has continued to say it would buy government debt and mortgage-backed securities on an unlimited basis, as necessary.
The Fed has debated purchasing Treasuries by targeting certain maturities along the yield curve — but officials have signalled such a move was not on the front burner. Officials are not expected to make big changes to the Fed’s emergency credit facilities either, believing they are helping to sustain markets, even if they are not all being widely used.