Fed faces viral wave, mounting risks to recovery

FAN Editor
U.S. House of Representatives Financial Services Committee hearing on oversight of the Treasury Department and Federal Reserve response to the outbreak of the coronavirus disease (COVID-19), in Washington
FILE PHOTO: Federal Reserve Chairman Jerome Powell, wearing a face mask, testifies before the House of Representatives Financial Services Committee during a hearing on oversight of the Treasury Department and Federal Reserve response to the outbreak of the coronavirus disease (COVID-19), on Capitol Hill in Washington, U.S., June 30, 2020. Tasos Katopodis/Pool via REUTERS

July 29, 2020

By Howard Schneider

(Reuters) – In a fast-changing global pandemic, this was not the turn U.S. Federal Reserve officials hoped for in early June, when their forecasts showed guarded optimism for a sharpish early economic rebound and steady slow growth to follow.

In the ensuing seven weeks, much has gone downhill.

The coronavirus pandemic has intensified and prompted new economic restrictions. Data has pointed to a possible slowdown in business and hiring. And so-far stalled talks in Washington about further government relief have pushed the country to the brink of a spending cliff.

(GRAPHIC – The Fed confronts a new wave The Fed confronts a new wave: https://graphics.reuters.com/USA-FED/FOMC/yzdvxnxxxvx/chart.png)

The risks to the U.S. recovery, in short, have grown substantially, and the new Fed policy statement to be released Wednesday afternoon will show just how seriously U.S. central bankers assess them. On Tuesday the Fed already made one nod to the outlook, extending from Sept. 30 to Dec. 31 the availability of the emergency credit programs it set up early in the pandemic when hopes of a quick “V” shaped recovery were still strong.

(GRAPHIC – The screws retighten? The screws retighten?: https://graphics.reuters.com/USA-ECONOMY/SMALLBIZ/xlbpgbnkevq/chart.png)

Fed officials “always feared a rushed reopening would lead to a virus resurgence that would cap the recovery,” said Krishna Guha, vice chairman of Evercore ISI. Now that the disease has raced back over the summer, the Fed “is grappling with whether this is a short-term or longer-range setback and what the implications are for its policy.”

The policy statement will be released at 2 pm EDT (1800 GMT) and Fed chair Jerome Powell is scheduled to hold a press conference a half hour later. No new economic projections will be issued at this meeting.

Nor is the Fed expected to announce any major policy decisions on Wednesday. Officials may point to a pending shift this fall in how it views its inflation target, or begin setting explicit goals for the jobless rate or inflation to be met before it considers raising interest rates from the current near-zero level.

That goal-based guidance seemed to be favored by policymakers according to minutes of the June Fed meeting, and several Fed analysts have said they expect it to be announced at the September Federal Open Market Committee session.

But with a dozen new programs rolled out since March to fight the economic fallout from the pandemic, the Fed is now watching to see how the economy and events evolve.

Those measures were meant largely as emergency support for an economy that likely registered a historic nosedive in the April through June quarter. First estimates of growth in gross domestic product for that period will be issued Thursday, and the median estimate of economists polled by Reuters is for an annualized decline of 34%.

In addition recent data suggest the hoped-for rebound, which started with an unexpected round of hiring in May and June, may have plateaued – a motivation for the Fed’s extending its emergency programs at least through the end of the year.

The official jobless rate fell from 14.7% in April to 11.1% in June, for example, but a survey by the Dallas Federal Reserve since then, as well as a new employment forecast by the St. Louis Federal Reserve, both suggest employment dipped this month. Last week new claims for unemployment insurance rose for the first time since March.

(GRAPHIC – A July jobs dip?: https://graphics.reuters.com/USA-FED/SMALLBIZ/gjnpwxemkvw/chart.png)

“The spike in virus cases is indeed sucking the oxygen out of the robust economic recovery” that seemed to be taking shape in May and June, wrote Bank of the West chief economist Scott Anderson in a July 24 analysis.

Also of concern, several of the key measures approved at the start of the pandemic to try to bolster families and businesses are coming to an end, perhaps most notably the $600 a week addition to unemployment insurance benefits. Members of Congress are debating a possible extension, but the benefit expires this week – a sign in general that the pandemic is on a different timetable than that envisioned by elected leaders when they approved the initial pandemic relief package.

The unemployment benefits are currently being received by around 30 million people, pumping $18 billion of disposable income into the economy each week. Along with the $520 billion loaned to small businesses under the Paycheck Protection Program, many firms and families were able to sustain spending, make rent and mortgage payments, and hold off what would have been a far worse economic shock

As the Fed meets the outcome of congressional negotiations over further relief remains uncertain – another risk, this one under human control – to the economic landscape.

“If these programs aren’t extended, layoffs could rise and job growth could weaken further. While the recession was abrupt, the labor market recovery is expected to be a long, uneven slog,” Anderson said.

Consumers may already be poised to buckle. The Conference Board’s index of consumer expectations dropped sharply in July. Major states like Florida, Texas and California saw large declines, which were “no doubt a result of the resurgence of COVID-19,” survey director Lynn Franco said on Tuesday.

“Looking ahead, consumers have grown less optimistic about the short-term outlook for the economy and labor market and remain subdued about their financial prospects. Such uncertainty about the short-term future does not bode well for the recovery, nor for consumer spending,” she said.

(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)

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