The Federal Open Market Committee meets on Wednesday for the last time before the US presidential election – and for the first time since it embraced a new monetary strategy that will be more tolerant of higher inflation and more committed to promoting full employment.
The US economy is still struggling with the shock of the Covid-19 pandemic, and with less fiscal support on the horizon, Jay Powell, Federal Reserve chairman and other officials will have to weigh what extra support they can offer for the recovery.
Here are five things to see:
A brighter forecast with reservations
Fed officials are expected to produce a rosier set of economic projections for this year than they did in June.
Unemployment has already fallen to 8.4 percent, well below the Fed̵
Meanwhile, output is expected to shrink by less than the 6.5 percent this year, which US central bankers predicted three months ago.
The improvements reflect better-than-expected results for the economy as it treated increases in infection over the summer. But the long-term projections may attract more attention as they extend to the end of 2023.
Will Fed officials expect US interest rates to remain at zero until then, especially given their ultra-dovish strategy shift announced last month, allowing them to let inflation run above the 2 percent target, before tightening the policy? And will their inflation forecasts show any overrun?
The Fed’s view remains that the United States is facing a long and challenging recovery and that major risks are on the horizon. The path of the coronavirus over the fall and winter as it crosses the seasonal flu is unclear; new fiscal support for the economy is highly questionable; and the looming election in the United States can be destabilizing if it delivers an uncertain outcome.
Sends the fiscal policy alarm
Sir. Powell – and other Fed officials – have made it clear that they would like Congress and the White House to agree on a new aid package to maintain the rebound. But after being ignored so far by the Trump administration and lawmakers on Capitol Hill, how hard will the Fed chairman go in prosecuting them for their inaction?
The Fed is concerned that the lack of a fiscal agreement will threaten the recovery and make its job more difficult. The US Federal Reserve does not want to be alone in supporting the recovery.
The Fed has also acknowledged that it lacks the tools to solve all the problems in the economy, as it can only borrow money but not use it to help businesses or households. And the Fed is very aware that its policies have done much to save financial markets from distress, but cannot provide benefits so easily to low-income and unemployed families.
New guide to a new era
After the Fed issued its historic announcement last month that it would tolerate higher inflation, investors wondered how such a policy would work in practice. The Fed and former officials have since given their support to the new monetary framework, but there have been few details on what action to take and when.
A potential tool that has garnered attention from both market participants and FOMC members is a more explicit form of forward-looking guidance. This will involve the Fed tying interest rate adjustments to specific economic measures such as unemployment or inflation.
One phrase in the FOMC statement to be monitored is whether the central bank will change its commitment to keep interest rates close to zero “until it is convinced that the economy has weathered recent events” to something firmer.
Another is whether the Fed will uphold its promise to assess economic conditions in relation to its “maximum employment target and its symmetrical inflation target of 2 percent”. Some economists have suggested that the Fed might adjust it to include a reference to an average inflation target of 2 percent “over time” – reflecting its new policy framework.
Investors arguing that the new guidance will be rolled out this week say the Fed risks a loss of credibility if it does not act quickly to strengthen its monetary shift.
A move on bond buying
This month, Fed Governor Lael Brainard said it will soon be important for “monetary policy to shift from stabilization to accommodation” as the economic recovery progresses and begins.
Investors expect that ethos will eventually apply to the US Federal Reserve’s bond buying program, which currently involves raising $ 80 billion. Of government securities of all maturities each month. The Fed has framed these purchases as necessary to ensure that financial markets function satisfactorily – a point it has done consistently since March, when trading conditions in the world’s largest government debt market seized.
The issue facing the Fed involves the duration of the debt it buys. As the federal government has borrowed more, the Treasury has shifted the bulk of its issuance from bills due in a year or less to longer-term debt. Many strategists are now calling for a similar move in the Fed’s purchases to ensure that economic conditions remain loose.
Find space for Main Street
The Fed has generally earned applause for rolling out a number of emergency credit facilities at the start of the pandemic, which stabilized and then encouraged financial markets.
But there is one exception. The Main Street Lending Program – created to help midsize businesses – has attracted few customers. Critics say its loan terms are too strict. Fighting sectors such as commercial real estate feel left out.
Sir. Powell may decide whether he is prepared to revise the program to make it more attractive, which will involve taking more credit risk with the Treasury.
“We do not think the Fed will capitulate to all industries and legislators, but we expect it will continue to look for ways in the coming weeks to expand and flex the Main Street to help more businesses,” he said. Ian Katz. , a policy analyst at Capital Alpha, in a recent note.
If the Main Street facility is seen as a flop, Congress may be able to redirect money set aside for other purposes – a prospect that Mr Powell may want to avert.