Jay Powell delivers dovish message to financial markets

Jay Powell could have used this week’s meeting of Federal Reserve policymakers to project confidence that the US economy had turned a corner after the shock of the coronavirus pandemic, with the jobs market showing signs of early recovery and equity prices continuing to rally. 

Instead, the Fed chairman and his fellow monetary policymakers reinforced their dire assessment of the country’s economic prospects for the coming years, which will require a heavy dose of support from the US central bank just about as far over the economic horizon as they can see.

In their first economic projections since December, Fed officials estimated that by 2022, the US would still be facing 5.5 per cent unemployment, far higher than pre-coronavirus levels, with core inflation at 1.7 per cent, still below its target of 2 per cent. Crucially, the forecasts showed that almost all top Fed officials expected to keep interest rates close to zero through to the end of 2022 — offering not the slightest hint of an early tightening. 

“It’s very clear to me that Powell has learned what not to do after seeing what happened in the wake of the last recession,” said Tim Duy, a professor of economics at the University of Oregon. “Back then, the Fed quickly talked about reversing the balance sheet, they talked about normalising interest rates, they really sent signals that it was going to be a short-term phenomenon, which led to tighter financial conditions and slowed the recovery. Powell is not going to make that same mistake.”

It was not just the forecasts that were dovish. The Fed chairman underscored the message during his news conference, saying he was “not even thinking about thinking about raising rates” and highlighting his concern that millions of Americans may fail to quickly recover their jobs even as restrictions on economic activity are lifted. Mr Powell also noted that the central bank had to be “humble” about its ability to move inflation up. 

“Powell has been clear that this is an unprecedented shock . . . he went out of the way to note that there is still a lot of risk in the economy,” said David LeDuc, chief investment officer for active fixed income at Mellon.

Tom Porcelli, chief US economist at RBC Capital Markets, deduced that the Fed would “remain incredibly accommodative for the foreseeable future”.

“It is pretty clear that [Mr Powell] is highly focused on making sure the labour backdrop has ample time to heal,” he said.

Investors were reassured not only by Mr Powell’s remarks but also by the Fed’s decision to place a floor under its asset purchases programme, rather than continue to reduce the pace as it has been doing on a weekly basis since the beginning of April.

In its statement, the Fed said it would increase its holdings of US Treasuries and agency mortgage-backed securities “at least at the current pace to sustain smooth market functioning”. Later on Wednesday it announced plans to buy approximately $80bn of Treasuries between June 12 and July 13, maintaining its roughly $20bn a week rate.

During his news conference, Mr Powell pushed back against criticism that the Fed’s easy money policy had unduly lifted asset prices — particularly the share values of risky companies — and risked destabilising markets down the road and exacerbating economic inequality.

“What our tools were put to work to do was to restore the markets to function, and I think some of that has really happened . . . and that’s a good thing,” Mr Powell said.

“I think our principal focus is on the state of the economy, and on the labour market, and on inflation,” he added, dismissing “the concept that we would hold back because we think asset prices are too high” as detrimental to “the people that we are actually legally supposed to be serving”. 

Investors expect riskier assets to do particularly well in an environment where the Fed has committed to support the economy and the smooth functioning of financial markets. “As long as there is a perception that the Fed has the bond market’s back and as long as there is a perception that the economy is going to improve in the future, I think stocks will continue to rally,” said Andrew Slimmon, senior portfolio manager for Morgan Stanley Investment Management.

Rather than putting the brakes on Fed support because of an unhealthy spike in financial markets, Mr Powell suggested there was a greater likelihood the Fed would take further action to bolster the US economy if it falters more than expected, either because of a second wave of Covid-19 infections or an underwhelming next round of fiscal stimulus.

Having previously ruled out negative rates, the Fed chairman said central bankers were discussing potential moves including “explicit” forward guidance on interest rates, which would tie any increases to particular macroeconomic milestones or dates, and a more structured asset purchase programme. Mr Powell said the usefulness of so-called yield curve control — targeting specific interest rates depending on the duration of debt — was still an “open question”, indicating it was not the first option. 

“They are so far from their goals . . . the focus is really going to be on ‘are we doing enough?’,” said Kathy Jones, chief fixed-income strategist at Charles Schwab. “The door is open if we get disappointing economic news or we get something that is particularly negative, like no more fiscal policy help.”

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