Fed on hold to assess scale of  pandemic trauma

The US Federal Reserve feels no urgency to offer big new monetary measures or guidance until it has a clearer grasp of the economic trauma inflicted by the coronavirus pandemic and the shape of a possible recovery, senior central bank officials have signalled in recent days.

Fed officials, including Jay Powell, the chair, are still ready to take more aggressive action if needed, after rebooting stricken corners of the financial markets through a massive rescue operation involving interest rate cuts, asset purchases and special lending schemes.

But they are not preparing to make a new move at their next monetary policy meeting in June. This is despite a gathering debate within the central bank about what kind of new measures the bank could take — including firmer commitments on forward guidance or asset purchases — which were detailed in minutes from last month’s Federal Open Market Committee meeting.

“This is a very unusual shock,” Richard Clarida, the Fed’s vice-chair, said on Thursday, speaking in a webcast with the New York Association of Business Economics.

“It’s going to take some time for us at the Fed to get some sense of what this economy, what the rebound, potentially can look like. So it’s natural for us to gather more data and insight on the situation as we think about potential refinements to our guidance and our balance sheet communication,” he added.

Fed officials have strenuously denied any interest in moving to negative rates, saying they are content with the tools they have and are sceptical about the effectiveness of moving below zero.

But they have been toying with ideas such as pledging not to raise rates until they reach certain economic milestones on unemployment and inflation, or until a certain date in the future. They have also been considering offering a more specific path for asset purchases, instead of the current open-ended, ad hoc policy.

Yet the Fed does not appear to be in a hurry to settle on a specific option. Part of the reason is that the US central bank is still heavily focused on implementing the crisis-fighting devices already announced. These include schemes to prop up troubled municipal, county and state governments, and medium-sized businesses desperate for credit that are due to be launched by the end of the month. Fed officials have said they are willing to change the terms of those facilities, or implement additional ones if new strains emerged in markets.

“They’re very focused on getting liquidity to the system and I think that they believe that they have made some real success on that if you look at market indicators,” said Michelle Meyer, an economist at Bank of America. “With the pure monetary policy tools, there are a number of things that are under review that they could put in place if they see the recovery is going to take longer . . .[but] you don’t need to put them in place while you are putting out the fire.”

The Fed still sees the economic outlook as unsettled. Senior US central bankers have warned that the short-term hit to the economy, with unemployment likely to keep soaring for the rest of this quarter, could lead to more lasting damage to America’s productive capacity and spending habits. They have cautioned that a full recovery may not occur until next year at the earliest. But as many states begin lifting the restrictions and lockdowns imposed to fight the virus, the outlook has not deteriorated sharply compared to their expectations a few weeks ago.

“It’s impossible to know exactly how and when workers and businesses will be fully back to work and when consumers will return to the businesses that are open,” John Williams, the New York Fed president, told business leaders from the Buffalo area this week. Mr Powell has even evoked a quip from John Kenneth Galbraith, the late economist and US diplomat, who said that economic forecasting existed to make astrology look respectable, to describe the Fed’s predicament. “We are now experiencing a whole new level of uncertainty, as questions only the virus can answer complicate the outlook,” he said.

There is a risk that the Fed may be forced to deploy more aggressive monetary weapons sooner than when it knows precisely what to expect, making their current pause quite tenuous. One danger is posed by a second wave of infections triggered by the premature reopening of economic activity, and another comes from global factors, such as renewed US-China tensions and worsening coronavirus-related downturns in Europe or emerging markets that might spill over to the US.

Another worry for the Fed might come from any failure by Congress and the White House to provide more meaningful fiscal support to the US economy in the coming months, on top of $3tn already approved. With expanded unemployment benefits enacted in March due to expire in July and states facing big budget shortfalls, the Fed has explicitly said that fiscal policy might have to step in where the central bank could not. “Direct fiscal support can make a critical difference, not just in helping families and businesses stay afloat in a time of need, but also in sustaining the productive capacity of the economy after we emerge from this downturn,” Mr Clarida said.

But even in the absence of those dire scenarios, and even if they are not planning to move imminently, Fed officials are mindful that they may soon have to reinforce their determination to support the economy for the long run.

“The economy is now in the hospital. It is being treated and the medicine is going in, but now the question is what is the dosage? As times goes on, the market is going to want to understand what the magnitude is of what is going to be done . . . and what they are trying to achieve,” said Ashish Shah, co-chief investment officer for fixed income at Goldman Sachs Asset Management. 

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