Policymakers at the Federal Reserve on Wednesday signaled that the worst of the pandemic-induced recession had passed as its summary of economic projections and “dot plot” rate forecast both implied that the zero interest-rate policy would remain in place throughout the central bank’s forecast horizon until the end of 2022.
Despite its optimistic outlook, the Fed remained cautious in its tone.
Despite that optimistic outlook, the Fed remained quite cautious in its tone and in Chairman Jerome Powell’s news conference following the Federal Open Market Committee’s meeting.
In particular, the dot plot signaled that monetary accommodation will remain extraordinary in the near to medium term. It is clear that the Fed does not anticipate a V-shaped economic recovery and is positioned to move forcefully to support the economy if there is an error in trade or fiscal policy.
Powell was also careful to note that the committee was briefed on yield curve control – a policy that targets long-term interest rates at a specific level that is then achieved by a central bank buying or selling as many bonds as necessary to hit the target rate — which we believe is the next policy regime that the Fed will adopt to accommodate the needs of the post-pandemic economy.
Powell carefully noted that the current unemployment rate of 13.3% most likely understates its true level and made a point to reinforce the technical annex inside the Bureau of Labor Statistics’ employment report, which stated that the unemployment rate was likely 3 percentage points above the official 13.3% estimate.
At the least, 20 million remain unemployed and gross domestic product in the current quarter will post a record decline — the RSM forecast is a decline of 41.5% — as well as making the point that much of the economy remains impaired
The Fed’s summary of economic projections indicated that the economy would shrink by 6.5% in 2020, down from its previous forecast of 2%, and then rebound by 5% in 2021. The longer-run estimate of growth stands at 1.9%. The unemployment rate will average 9.3% in 2020, down from its previous estimate of 3.5%, then fall to 6.5% in 2021 with the longer-run average remaining at 4.1%. The forecast of core inflation was revised down from 1.9% to 1% for 2020 and the Fed retained its longer-run estimate of 2%, in line with its current inflation target.
One of the more interesting aspects of the Fed’s summary of economic projections was that the Fed did not change the long-term estimates of growth at 1.9% or the unemployment rate of 4.1%. This would imply that the Fed believes that there has been no long-run damage to the economy.
This is quite encouraging from a policymaking point of view, but in our estimation it is far too early to come to that conclusion. This may come back to bite the Fed should there be an error in fiscal or trade policy, or a second wave that causes another downturn or an extended period of slower growth in the domestic economy.
In a separate note, the Fed indicated that it would continue to increase System Open Market Account holdings of Treasury securities at the current pace, which is the equivalent of approximately $80 billion per month and continue to increase SOMA holdings of agency mortgage-backed securities at the current pace, which is the equivalent of approximately $40 billion per month.
Total purchases during this monthly period are expected to be approximately $96 billion, which includes approximately $56 billion in purchases to reinvest principal payments from existing SOMA holdings of agency debt and agency MBS anticipated to be received in the month of June.
In addition, the Open Market Desk plans to continue to increase SOMA holdings of agency commercial mortgage-backed securities at the current pace by conducting weekly operations of approximately $250 million to $500 million. Purchases will include the reinvestment of principal payments from SOMA holdings of agency CMBS.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
