Fed in a holding pattern,

Blog - 2 min read

The Federal Reserve announced no major policy changes at the June Federal Open Market Committee (FOMC) meeting, as expected. The statement contained few changes relative to last month's meeting, maintaining the dovish bias and emphasising depressed activity, muted inflation and "considerable risks" to the outlook.

While Chairman Powell acknowledged the recent easing in financial conditions (see chart 1), and some early signs of stabilisation in the data, including the surprise jobs report in May, the Fed remains deeply concerned about the trajectory of the recovery in light of continued uncertainty.

 
 

The Summary of Economic Projections showed the FOMC members expect the economy to contract by 6.5 per cent in 2020 and to rebound by 5 per cent in 2021 and 3.5 per cent in 2022. PCE (Personal Consumption Expenditures) inflation is projected to stay below target through 2022.

The unemployment rate is expected to end this year at 9.3 per cent, converging to 5.5 per cent by the end of the forecasting horizon in 2022. Interestingly, the long-run unemployment rate was left unchanged at 4.1 per cent, suggesting no expectation for permanent damage to the labour market, at least at this point. At the same time, the FOMC also expects no increases in the funds rate through 2022.
 
Through its resolute action during the crisis, the Fed has bought itself some breathing room. As it gathers more information about the shape and speed of the recovery as well as more evidence of the extent of permanent damage to the economy, it will be in a better position to respond later in the year. Powell emphasised that more policy support might be needed both from the Fed and Congress, particularly if broad measures of unemployment point to rising risks of permanent damage to the labour market.
 
I believe the Fed will have to do more to support the economy over the next few months. After the initial re-opening bounce, the path to full employment will become a lot more challenging. In addition, risks related to subsequent waves of infection, the upcoming elections, weak global recovery and trade tensions would likely complicate the recovery path.
 
I expect the Fed to adopt some form of yield curve control and to introduce outcome-based forward guidance at its September meeting. Risks are skewed towards further easing action, however, especially if any second wave of the virus is not effectively controlled.