The Fed Commits to Help for the Long Haul


At its June policy meeting, the Federal Reserve (Fed) pledged continued support to a U.S. economy battling the near- and longer-term effects of the coronavirus crisis. Fed Chair Jerome Powell said the central bank is committed “to do whatever we can for as long as it takes” to restore the nation’s economic health in these unprecedented times.

Specifically, the Fed indicated interest rates would remain unchanged at near-0% through 2022. This should help the economy rebound later this year. The central bank also committed to purchasing at least $80 billion in U.S. Treasuries and $40 billion of mortgage-backed securities per month. This effectively ended the Fed’s recent tapering of bond purchases, which had caused a sharp jump in the 10-year Treasury yield in the week before the Fed meeting.

We believe the central bank’s “whatever it takes” approach remains appropriate. While the Fed is employing all policy tools at its disposal, some virus developments are beyond policymakers’ control. These developments continue to influence economic data.

Quick, Comprehensive Action Aided Markets

Since early March, the Fed launched—and subsequently expanded—numerous programs to help support the economy and stabilize financial markets. We believe these facilities will continue to improve liquidity in several key markets. The additional liquidity should help reduce stress on credit-sensitive fixed-income assets.

The Fed’s broad effort includes plans resurrected from the 2008 financial crisis, along with some new programs:

Rate cuts

In two emergency moves in early March, the Fed slashed the federal funds rate target range to 0% to 0.25%. Before these cuts, the rate range had been 1.50% to 1.75% since October 31, 2019.

Quantitative easing (QE)

Policymakers launched effectively unlimited QE, including purchases of Treasuries and agency backed mortgage securities. Unlike the Fed’s prior QE, today’s bond buying program includes:

This expansion provided positive technical support to sectors that struggled at the height of the late-March market sell-off. So far, QE has pushed the Fed’s balance sheet to more than $7.2 trillion—the biggest expansion in history. The Fed’s balance sheet was $4.2 trillion at the start of the year.

Emergency lending facilities

The Fed unveiled several emergency lending facilities to:

  • Restore liquidity to short-term funding markets
  • Help state and local governments manage cash flows
  • Provide loans to small and mid-sized businesses
  •  Avoid credit disruptions

Some facilities are like ones the Fed used during the financial crisis, while others are new.

Fed Sees Economic Bounce Back in 2021 and Beyond

In addition to releasing its monetary policy statement, the Fed shared its first set of 2020 economic projections during the June meeting. Policymakers expect the U.S. economy to shrink 6.5% in 2020, due to the unprecedented nationwide shutdown of business activity in response to the pandemic.

However, the Fed’s long-term economic growth forecast changed only slightly from December 2019, slipping from 1.9% to 1.8%. This underscores the Fed’s belief the economy isn’t facing permanent damage.

Powell noted the Fed expects an economic rebound to begin in the second half of 2020, with growth surging to 5% in 2021. He also said the expansion should continue for the next couple of years, supported by near-0% interest rates.

“We’re not thinking about raising rates,” Powell said. “… What we’re thinking about is providing support for the economy. We think this is going to take some time.”

“We’re not thinking about raising rates,” Powell said. “… What we’re thinking about is providing support for the economy. We think this is going to take some time.”

 

Fed in a Holding Pattern

We agree with the Fed’s cautious economic outlook. There’s lingering uncertainty surrounding the short- and longer-term effects of the virus on consumer and business behavior. For example, while recent labor market gains are encouraging, jobs data have a long way to go to reach pre-pandemic levels.

We believe the Fed’s June meeting represents a holding pattern for the summer. We expect the next shift in policy to take place at the Fed’s September meeting. Of course, this depends on virus developments and how the economy is faring.

Financial markets will likely focus on the Fed’s bond-buying strategy. We think the Fed’s crisis-initiated QE may turn into a more permanent fixture of Fed policy. Especially as it seeks to assure financial market stability and support the medium-term economic recovery.

It’s highly possible policymakers will implement some form of open-ended bond buying that persists beyond 2020. Although the Fed hasn’t provided details about its longer-term bond-buying plans, we expect the central bank to clarify its strategy in the fall as the economic picture sharpens.

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