“They no longer have the luxury of time”
Joggers walk past the Marriner S. Eccles Federal Reserve Building in Washington, DC on Tuesday, August 18, 2020.
Erin Scott | Bloomberg | Getty Images
With inflation still elusive and a bevy of questions surrounding an economy that has just set a quarterly growth record, the Federal Reserve must choose between waiting for conditions to unfold or acting now to provide additional help.
Most market participants expect the Federal Open Market Committee to remain silent at its policy meeting on Wednesday and Thursday.
However, officials are expected to discuss the policy options open to them at this point, and with so much uncertainty surrounding the current situation, it wouldn’t be all that surprising to see them make some sort of movement.
“I just don’t see the benefits of waiting until December,” said Aneta Markowska, chief financial economist at Jefferies. “A lot has changed in the past two weeks. Almost all of the concerns they reported in September have materialized or are in the process of materializing. So they no longer have the luxury of time.”
This sense of urgency seems incongruous with an economy which just recorded a 33.1% annualized GDP gain in the third quarter and which has restored 11.4 million jobs since May and is in the midst of a real estate boom. .
However, economists at the Fed and elsewhere fear the best gains are behind as the major tailwind in government stimulus funding has dried up. The rise in coronavirus cases is raising concerns of renewed economic pressure as communities face pressure to reinstate restrictions on businesses.
And the Fed has another problem in its hands: a market that doesn’t necessarily believe in the central bank’s recent efforts to push inflation up and promises not to raise interest rates until that target does. is not achieved.
Inflation expectations, according to market indicators, have actually fallen slightly since the Fed approved an approach in which it will let inflation exceed its 2% target after periods like much of the past decade. , where it fell below that level. In the past, the Fed used falling unemployment as a warning signal to raise rates to avoid inflation, which it will no longer do.
A Commerce Department report said on Friday that headline inflation, according to the Fed’s preferred gauge, climbed to 1.4% for September, still well below the pace desired by the central bank.
“The market just wanted more follow-up and obviously didn’t get it,” Markowska said. “In September, maybe they felt like there was no urgency to do anything immediately. What has changed between then and now is that the urgency has increased.”
A change to the main street
In fact, the Fed has already taken one more step that the market has been watching.
The Fed said on Friday it was easing some of the terms of its Main Street loan program for small and medium-sized businesses. The central bank reduced the minimum loan to $ 100,000 from $ 250,000 and eased debt restrictions for applicants.
Beyond that, policymakers have a decreasing number of options over which Fed officials themselves have expressed varying levels of doubt.
“If a severe resurgence of the winter virus turns out to be more damaging economically than expected and the FOMC wanted to respond, its options would be limited,” Goldman Sachs economist David Mericle said in a note. “The most likely response would be to adjust the composition or pace of asset purchases, but Fed officials have expressed only mixed support for such a move as they consider it unlikely that it will be. particularly effective. “
Indeed, market participants largely expect the Fed’s next move to be to change its asset purchase program. The Fed buys a minimum of $ 120 billion per month in treasury bills and mortgage-backed securities, and it could change the mix of those purchases to meet various goals.
On the one hand, he might just increase the level he buys. It could also lengthen bond durations to influence yields further up the curve. Finally, the Fed can continue to change the language it uses to frame purchasing objectives, from facilitating the functioning of the market to supporting the economy more broadly.
“At the moment, we don’t think the Fed will do much more, but [Chairman Jerome] Powell will likely reiterate that he is prepared to do whatever is necessary to support the economic environment, ”RBC Capital Markets economists said in a note.
“While we don’t expect the committee to make any changes at this meeting, if the early days of the virus are any indication, we expect the Fed will not hesitate to act quickly if the number of cases are increasing to such an extent that state governments begin to shut down sectors of the economy, ”they added.
The Fed will closely monitor financial conditions over the next few days, and its meeting will end after a presidential election, the results of which could indicate just how aggressive the fiscal stimulus could be.
The recent decline in the stock market is something officials will pay attention to, as are the tightening of lending standards as well as the pressure on consumers from a potential economic downturn induced by the virus.
While the committee may choose not to address these points specifically in its post-meeting statement, Powell will stand a chance at his press conference afterwards.
Correction: The Federal Open Market Committee meets Wednesday and Thursday. An earlier version distorted the days.