Most of the media are focused on the virus outbreak and its implications — but Bloomberg is reporting that events have “ambushed” the Fed — that for more than a year, America’s central bankers have been brainstorming about how to tackle the next downturn while assuming they had time to travel around the country figuring it out.
As it turns out, they had “no time at all.”
Fed Chair Jerome Powell and his colleagues began 2020 betting they could keep interest rates steady in a strengthening economy. They’re now in a “race to save an 11-year expansion from the coronavirus, which has wreaked havoc across financial markets and threatens to tip the U.S. into recession too — if it hasn’t done so already.”
In less than two weeks, the Fed has been forced into two emergency rate cuts, accelerated purchases of Treasury bonds, and pledged to pump trillions into funding markets — a far cry from the “Fed Listens” tour that policy makers announced in late 2018 to glean ideas from business leaders and the general public about how to set monetary policy.
At that point, the central bank had just spent three years ratcheting its benchmark rate back up toward historically normal levels, after hitting zero during the last financial crisis in 2008. But it didn’t make it very far the Fed over the weekend has undertaken a host of actions to head off COVID-19 impacts of actions as the economy faces new challenges.
This clearly invites the question: What next? As recently as October, according to minutes of their deliberations, Fed officials were sounding broadly content with the crisis toolkit that they deployed in 2008 and after, although open to tweaks. Now they may have to resort to all of those measures and more — and roll them out fast.
Those include commitments to keeping short-term rates pinned at zero and the bond-buying programs known as quantitative easing.
Bloomberg also thinks that this time, the Fed could go further and follow the lead of the Bank of Japan, whose policy of yield-curve control aims to hold longer-term rates down too. And even that may fall short. “The Fed doesn’t really have the scope to do what it needs to do,” said an ex official. “The takeaway from that, I guess, is monetary policy can’t really do much at this stage.”
That’s one reason why proposals more radical than anything on the Fed’s own radar have been bandied about with growing urgency by monetary policy wonks.
Negative rates, already attempted in Europe and Japan, have their advocates — including President Trump — though Fed officials dislike the idea. There’s also talk of authorizing fed purchases of a wider range of securities than the government-backed ones it acquired in past rounds of QE.
The longer-term problem that all these proposals attempt to solve — limited central-bank traction on the economy during downturns — was reflected in the short-run gyrations of markets these past couple of weeks. The Fed was taking action, Bloomberg said, but it wasn’t able to halt a gathering rout.
When it looked like no immediate help was on the way, stocks and Treasury yields plunged. When it looked like it might be — for example, during the president’s declaration of a national emergency on Friday afternoon — they surged. In Europe too, fiscal authorities were getting a rude wake-up call that spurred them into action.
Even so, on Saturday the President continued to blame the Fed for dragging its feet, demanding more rate cuts and saying he could demote Powell if he wanted to.
Nothing remotely like this was in the forecast 16 months ago when Fed officials launched their rethink. They expected rates to reach around 3% by 2020, and were mostly preoccupied with why they kept falling short of the 2% inflation target.
In the coronavirus world, the economy is set to cool rapidly regardless of where interest rates are as spending in some areas falls and workers get laid off.
This time around the damage probably won’t be as severe, according to David Wilcox, a former director of research and statistics at the Fed’s Board of Governors, who is now at the Peterson Institute for International Economics.
He foresees a “sharp downdraft in economic activity,” but expects a moment when health authorities sound the all-clear. “That’s going to provide a big psychological lift, and I think there will be a big economic lift as well.”
The latter idea fits with the reflections of some policy makers themselves including Fed Governor Lael Brainard who criticized the tightening that began in 2015 and argued that it would’ve been better to “delay liftoff.”
The review was designed to answer that kind of strategic question. But with yields on even 30-year government bonds far below the 2% inflation target, investors are signaling that the Fed won’t have to worry about the timing of a rate-hiking cycle for a long time. Instead, firefighting tactics are again the order of the day.
Looking back on the period since 2008, Nathan Sheets — a former Fed and Treasury official who’s now chief economist at PGIM Fixed Income in Newark, New Jersey — says, “The European Central Bank has been stuck at zero. The Bank of Japan has been stuck at zero for even longer,” he said.
So, we will see. The coming months are expected to see a wide range of efforts to avoid economic downturns and global economic slowdowns — proposals that producers should watch closely as these efforts are debated and tried out, Washington Insider believes.
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