Fed warns of lasting ‘medium-term’ economic damage

The Federal Reserve warned of lasting “medium-term” economic fallout from the coronavirus pandemic as it kept its main interest rate close to zero and pledged readiness for further action.

At the end of a two-day meeting on Wednesday, the Federal Open Market Committee stopped short of any big new monetary policy action or guidance, after injecting a heavy dose of stimulus to prop up the economy and markets in the past two months.

But it said it was prepared to take additional steps in the face of an economic picture that appeared bleaker — at one point, Jay Powell, the Fed chair, described events as “heartbreaking” — than it did a month ago.

“The Federal Reserve is committed to using its full range of tools to support the US economy in this challenging time,” it said. “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.”

The target range of the federal funds rate was maintained between 0 and 0.25 per cent, its level since March 15, when Fed policymakers slashed rates and boosted asset purchases to shield the economy from the coronavirus pandemic. 

In its statement, the FOMC said it would keep rates close to zero “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals” — using the same language as in March.

The statement came after new data exposed the economic damage already inflicted by the Covid-19 outbreak on the US economy. GDP contracted at an annualised rate of 4.8 per cent in the first quarter of the year, its worst performance since the Great Recession, and the slump is expected to be deeper in the second quarter after at least 26m people were left newly unemployed.

During his press conference, Mr Powell said the Fed would move “forcefully, proactively and aggressively” to support the economy, but added a call for further action from Congress and the White House, saying “direct fiscal support” might be needed to “limit long-lasting damage”.

More than $3tn in fiscal stimulus measures have been put in place, and negotiations are starting on a new package. Mr Powell said this was the time to use “the great fiscal power of the United States”.

Gene Tannuzzo, deputy global head of fixed income at Columbia Threadneedle, said investors were encouraged by the Fed’s “strong” language about the economic outlook, seeing it as a sign of the central bank’s urgency in supporting the economy and financial markets.

“This is a situation where we want the Fed to describe the outlook as grimly as possible, because it accentuates their sensitivity to it,” he said.

Mr Powell pointed to three big medium-term risk factors: the fact that the trajectory of the virus was still “shrouded in uncertainty”, the danger the US would lose some of its productive capacity as workers became disconnected from the labour force, and the global dimension of the crisis.

US equities were little changed following the Fed announcement. The S&P 500 held on to earlier gains, rising 2.7 per cent, while the tech-heavy Nasdaq Composite climbed more than 3 per cent.

The benchmark 10-year Treasury note sold off slightly, with the yield inching higher by 0.02 percentage points to 0.63 per cent. The policy-sensitive two-year note saw its yield fall 0.01 percentage points to 0.2 per cent. Yields fall as prices rise. The dollar index slipped 0.3 per cent.

Before this week’s meeting, the Fed had already responded to the crisis with lower interest rates, a sharp expansion of its balance sheet, the establishment of dollar swap lines with foreign central banks and the creation of lending facilities with the US Treasury to offer credit to struggling businesses. Trading conditions in critical debt markets have stabilised as a result, buoyed by the Fed’s commitment to act as needed.

“The committee will closely monitor market conditions and is prepared to adjust its plans as appropriate,” the Fed added in its statement.

Mr Powell has previously said the US central bank is not considering a move towards negative interest rates, as some of its counterparts around the world have done. However, the Fed still has scope to firm up its commitment to ultra-low rates for a long time, by setting specific targets based on unemployment and inflation levels for any increase. It also has room to expand its asset purchases and credit facilities.

Mr Powell said he felt Fed policy was now in “the right place” and markets expected rates to be at ultra-low levels “for a good while”. He added that the Fed was not “in any hurry” to withdraw support for the economy.

But economists said that the question of what more the central bank should do would rear its head again soon.

“The Fed is highlighting all the work it’s doing to support the economy and promising to do more if necessary,” said James McCann, senior global economist at Aberdeen Standard Investments. “It’s sensible that the Fed take a brief pause to establish the impact of what they’ve already done. But they cannot afford to rest on their laurels.”

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