Federal Reserve policymakers are gathering this week for their regularly scheduled meeting — after taking an extraordinarily aggressive series of steps to ease economic hardship and reassure investors in the face of the coronavirus pandemic.
Although no big policy shifts are expected, there is plenty to look out for — and challenges for chairman Jay Powell — as the Fed navigates the next stage of its response to the crisis.
Calibrating the outlook
In some of his last public remarks at the end of May, Mr Powell trotted out the old quip by the late economist John Kenneth Galbraith that economic forecasting existed to make astrology look respectable. Nevertheless, the Fed will release economic forecasts for the first time since December.
Michael Feroli, an economist at JPMorgan, said he expected the median projection to show the US economy shrinking by 6 per cent in 2020, with joblessness around 10-11 per cent and interest rates stuck close to zero for years. Such projections would be roughly in line with statements by Fed officials that the economy is heading for a protracted slump.
A deviation to the upside — such as officials signalling they expect interest rates to rise — could unsettle markets. The Fed has ruled out moving to negative rates, so any projection of below-zero rates would be a shocker.
Fed officials have indicated it would be too early to offer more formal guidance on US interest rates, tying any increase to specific macroeconomic benchmarks. The same goes for launching a formal quantitative easing programme with fixed amounts of asset purchases, as opposed to the current policy of buying as many bonds as needed. A move towards either stance would be a surprise.
The bank could still reinforce its dovishness in other ways, including by strengthening the language in its statement to say it is “strongly committed” to using all its tools to support the economy, as Mr Powell did in late May, as opposed to “committed”, which is how the Federal Open Market Committee put it on April 1. Mr Powell could also characterise Fed discussions about its next steps.
“The Fed has been able to delay providing longer-term guidance because of the crisis environment. But we are moving out of that environment, and the market is hungry for better guidance as to what comes next,” said Jon Hill, a rates strategist at BMO Capital Markets.
The surging markets
Even when the economy was still growing and the pre-pandemic labour market was tight, the Fed was not particularly worried about asset bubbles, so it is hard to imagine its officials will be concerned with the country experiencing what they believe to be disinflationary shock.
They have also been comforted by the general recovery in financial markets after turmoil that sparked concerns about the short-term funding markets — and even US Treasury markets.
But the rally has been so fierce — with investors pouring into the securities of highly indebted, and even bankrupt, companies — that some analysts worry the market action could threaten financial stability.
Discussing the protests
Since Mr Powell last spoke, the US has been convulsed by the mass protests against racial injustice and police brutality — and the Fed chairman may have to address the issue.
A week ago, with President Donald Trump threatening to deploy the military to quash the unrest, and episodes of looting and vandalism on the streets, the situation was emerging as a potential new risk to the economy on top of the hit from coronavirus.
Since then Mr Trump has pulled back, curfews have been lifted and the protests have become even more peaceful. Still, the lack of social distancing at the demonstrations could spur a second wave of infections, which would be very economically damaging.
Mr Powell, who has been sensitive to addressing inequality and the distributional effects of economic policies since becoming Fed chairman, may have to reconcile any sympathy for the protests with warnings about their unintended consequences.
Justifying the lending facilities
A big part of the Fed response to the crisis has been the establishment of a series of facilities, including some backed by funding from the US Treasury, to lend to struggling businesses and local governments.
The central bank acknowledged that it had crossed some “red lines” in setting them up, moving into new terrain. But the announcement effect has been much more significant than the real impact.
The Fed has still not launched a flagship “Main Street” lending plan, intended for small and medium-sized businesses, and was forced to revise its terms twice after criticism it was too stringent. Its corporate debt buying facilities have struggled to get off the ground, and a lending scheme for states and local governments was recently tapped by Illinois for the first time.
Mr Powell will have to address to what extent, and in what form, these facilities still serve a purpose.
With momentum for a new high-priced stimulus package visibly fading on Capitol Hill due to resistance from Republicans, Mr Powell is likely to make a delicate push for lawmakers not to take their feet off the pedal.
The Fed chairman has made appeals for fiscal support in the past, but this one may be more urgent. If Congress does not act by July, millions of Americans will lose enhanced unemployment benefits, which have served as a cushion during the recession. Meanwhile, the impact of $1,200 per person cheques sent to households by the federal government is fading.
To the extent that massive fiscal support has helped to avoid a deeper economic plunge, Mr Powell could insist that its early withdrawal threatens a potential rebound.