Lower for Longer
The FOMC completed its two-day deliberations on Wednesday. The usual Press Release (PRL) came out just prior to Fed chair Jerome Powell’s press conference at 1430 Hrs EDT on the same day.
As is normal with September meetings the Fed also published its latest economic forecast.
The below are my observations.
Background
The US economy
Has partially rebounded from the punishing COVID-19 recession more swiftly than expected.
U.S. industrial production rose below forecasts in August while the New York Empire State manufacturing index rose sharply in September.
Has performed somewhat better than expected since the Fed’s last projections in June. GDP fell at a record 31.7% annual rate in the second quarter, slightly better than the initial 32.9% estimate.
While the unemployment rate has improved (see below), the lack of congressional action on another fiscal-aid package leaves the future path of the economy in doubt
Unemployment
The US has recovered slightly fewer than half the 22 million jobs shed in early spring. There are 11 million still unemployed.
The unemployment rate fell sharply in August, to 8.4% from 10.2%.
Current unemployment rate of 8.4% is already below the FOMC’s most recent median 2020 forecast of 9.3%
COVID
While COVID-19 surges in the South and West led some states to pause or reverse plans to allow shuttered businesses to reopen, hospitalisations and death tolls have improved in some states recently
Inflation
Last Friday, the US released its August 2020 inflation figures. The month-on-month change came in higher than expected at 0.4% taking the headline rate of inflation to 1.7%. The Fed’s
But the Fed targets a broader measure of inflation called the personal consumer expenditure deflator (PCE). In July, this was running at only 1.0%, a full 0.6% lower than the equivalent July headline CPI.
Fiscal policy
The Fed can’t generate demand. For that we will need to see additional fiscal stimulus
Government financial aid to businesses and the unemployed has virtually dried up and talks on another package are at an impasse. At least 29.6 million people were on unemployment benefits in August. Government money was credited for the sharp rebound in economic activity.
Republican and Democratic parties are still so far apart. Conservative leadership is still dealing with the backlash from its voter base over allowing higher unemployment benefits in the previous bill. That is why they are eyeing a much smaller stimulus package this time. Meanwhile, Nancy Pelosi’s Democrats want a massive $3 trillion.
There is a $1.5 trillion plan from a bipartisan coalition of lawmakers but let’s see.
The latest FOMC
Projections, PRL and press conference
Wednesday marked the first time Fed forecasts stretched out to 2023. The Fed signaled that its interest-rate policy will remain unchanged and close to zero through the end of 2023. Yet the majority on the FOMC still expect no rate hike at least until 2024.
This was the first Fed meeting under its new flexible inflation target strategy. This allows the Fed to let inflation run above 2%, and essentially calls for rates to remain lower for longer.
Fed officials produced a rosier set of economic projections for 2020 than they did in June. The Fed upgraded its GDP forecast for all of 2020 to a 3.7% decline from a 6.5% fall in its June estimate. The Fed also upgraded the unemployment rate by end 2020 to 7.6% from 9.3% in its June estimate.
Powell as expected reiterated the need for Congress to do more to support the US economy
My take
Ok enough of reciting facts and figures and time to take off my gloves.
The recovery
Forget, WW, square root shaped etc.
As of now, a return to 2019 output levels are due only by the end of next year – a Nike-swoosh recovery. Things can change, however, if we have another wave and/or the vaccine is delayed or is ineffective.
The twin pillars
Extract from the Fed PRL on 16 September 2020 (highlighted words mine):
“The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”
I will analyse the highlighted words which for long have been the twin pillars of Fed policy.
Maximum employment or maximum confusion?
What the hell is maximum employment?
The Fed has consistently refused to give a specific number or even a formula.
The reason trotted out is that there are too many variables involved such as labor participation, although Powell yesterday slyly suggested that “there is a lot to like in a 3.5% unemployment rate though.”
Does that mean 3.5% is the magic number?
Don’t bet on it. For several reasons.
The Philips curve (where unemployment rate and inflation are roughly inversely related) is long broken.
While the Fed keeps saying (and it is true) that monetary policy cannot target specific workers or industries, these arguments ignore the huge impact that a long economic expansion and low overall unemployment rate has on marginalised workers. The unemployment rate of Black workers is, on average, twice that of white workers, so it takes a prolonged expansion before the unemployment rate of Black workers gets below recession-type levels. With alarmingly high inequality and simmering racial tensions, this may be a factor in future monetary policy and the Fed might just decide to let the expansion run on for longer (with a gradually declining unemployment rate) without tightening.
All this means that Powell of course doesn’t want to be pinned to a number and so we don’t have a number.
Perhaps maximum employment is like Porn; you’ll know it when you see it.
Has anybody seen Mr. Inflation?
Which brings me to my second point. The big bad wolf of inflation.
Powell said that the Fed will tolerate a “moderate overshoot of inflation for some time”. What exactly is “moderate overshoot” and how long is this “some time”?
Also, did anyone note the weird fact that the Fed's "average inflation" does not appear in its own projections to the end of 2023? I mean does it even believe in its own target of 2% anymore?
Because if I were the Fed I wouldn’t, given its dismal record in creating inflation. The Fed’s PCE has, since the beginning of 2010, been at or above 2% in just 13 months out of 120 months or barely 10% of the time.
Powell is not naively optimistic about inflation. He needs to talk of the myth of inflation because it believes deflationary expectations would be deadly for the economy, pulling down consumption as consumers defer purchases and damaging banks and the stock markets as few will want to borrow or consume.
Policy uncertainty?
The upshot is that however articulate, measured and precise Mr. Powell likes to sound on stage, apart from the high likelihood that rates will be “low for long” (the new mantra), we have little or no visibility on monetary policy of the most powerful central bank on the planet. This is thanks mainly to the two above measures that are either frustratingly imprecise and/or meaningless.
But hold on Binod you may say. Surely the fact that maximum employment is extremely difficult to pinpoint and that inflation may never happen means that the Fed will never raise rates.
To which I reply that the Fed will raise rates at some point after 2023. It must do so not to fight the non-existent wolf of inflation but to create enough buffer so that it can cut rates in case of another crisis. That’s why Yellen raised rates in December 2015 after seven years of Zero Interest Rate Policy (ZIRP).
In other words, rate hikes are purely for fighting a war, not against inflation but against some unknown crisis in the distant future. It’s not a bad idea, if you go by the proverb “the end justifies the means”.
Main street lending
Powell keeps saying that “we are a lending body not spending body” but even the lending has some snafus. Such as the failure of the Fed to support lending to small and medium-sized for-profit businesses.
The $ 600 bln main street lending program was set up by the Fed for just that but has seen a mere $ 2 bln or 4% disbursed so far with 98% of the moneys lying unutilized.
I suspect one reason is that the Fed, Congress and Treasury shockingly cannot agree on how to implement it. For example, it’s rumoured that the Treasury has asked banks to target zero losses (!!) and of course this is completely impractical as some borrowers will face difficulties and may default.
Powell said delicately that “some changes will be made”.
Conclusion
Things are rarely what they seem to be.
The more things change the more they remain the same.
We know what we don’t know.
Perhaps we should just accept that and move on.