Fed Expects Years-Long Recovery from Virus, Rates Near Zero for Foreseeable Future
by Craig Dismuke, Dudley Carter
The FOMC voted unanimously to keep monetary policy unchanged in their June 9-10 meeting, making only minor changes to their Official Statement but marking down their economic projections dramatically from their December 2019 projections.
The Official Statement was changed to note an improvement in financial conditions since the April Statement but did not reference the better-than-expected May jobs report. The June Statement notes that “Financial conditions have improved” but continues to reference “sharp declines in economic activity and a surge in job losses.”
As it relates to asset purchases, the Fed was previously purchasing Treasury securities, Agency RMBS, and Agency CMBS in “the amounts needed to sustain smooth market functioning.” The June Statement and Implementation Note were both changed to indicate that, going forward, the Fed will purchase amounts “at least” at the current pace, putting a floor on monthly purchase volumes. Subsequent to the Official Statement, the New York Fed released a statement clarifying that the “current pace” is approximately $80 billion in Treasurys and $40 billion in agency MBS. The purpose of the asset purchases continues to be characterized as to ensure the smooth functioning of the markets, not the easing of monetary policy.
The real message in the official releases was seen in the Summary of Economic Projections. After skipping their March SEP because of the high level of uncertainty plaguing forecasts at the time, the Fed released a new set of projections which were markedly weaker. They, collectively, reflect an expectation that it will take years for the economy to recover from the damage that has been, and is being, done through the virus’s containment efforts. The economy is expected to contract 6.5% in 2020 before rebounding 5.0% in 2021 and 3.5% in 2022. The median expectation for longer-run growth was notched down from 1.9% to 1.8%. After coming into the pandemic at 3.5%, the unemployment rate is now expected to end 2020 at 9.3%, end 2021 at 6.5%, and end 2022 at 5.5%. Officials continue to believe the natural rate of unemployment longer-run is 4.1%, an indication of how much slack they expect to remain in the labor market two-and-a-half years from now. Projections for inflation were lowered to reflect a persistent undershoot of the 2.0-percent target throughout 2022.
As for their target Federal Funds rate, all participants expect the target range to remain unchanged through 2022 with only two exceptions. One official projects a target range of 0.25%-0.50% by year-end 2022 and one official projects a range of 1.00%-1.25%.
The message is clear: Fed officials believe the economic damage from the pandemic has been significant, it will require years to recover, there will be a significant amount of labor slack through 2022, and interest rates will be anchored near-zero for the foreseeable future.