Fed: Giving Fiscal a Nudge

Published on October 6, 2020
SGH Insight
In his virtual keynote speech before the National Association of Business Economics later this morning, Federal Reserve Chairman Jerome Powell can be expected to elaborate on the Fed’s new policy framework. And while he may also note the resilience of the US economy in its rebound so far from the depths of March, he is also likely to warn in grave tones the easiest part of the recovery is now behind us.

** More to the point, with the negotiations for the Phase IV fiscal legislation between House Speaker Nancy Pelosi and Treasury Secretary Steve Mnuchin now nearing a critical make or break moment this week, we think the Fed Chairman is likely to adopt a significantly harder edge in making the case for more fiscal policy as soon as politically possible.

** And while it is highly doubtful Chairman Powell would publicly make an explicit link, we also think a fiscal deal this month would make it far more likely if not near certain that the Federal Open Market Committee Fed will complete its shift to a more accommodative monetary policy stance at its December meeting, with a weighting in its current asset purchases to the longer term treasuries.
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Policy Validation

(Bloomberg 10/6/20)

Powell Warns of Weak U.S. Recovery Without Enough Government Aid
‘Risks of overdoing it’ are smaller than too little stimulus
GOP opposition to larger fiscal package has hampered a deal
Federal Reserve Chair Jerome Powell warned of a weak U.S. recovery without sufficient government aid and said providing too much stimulus wouldn’t be a problem.

Powell’s remarks Tuesday came amid Republicans’ opposition to a larger relief package that’s kept talks with Democrats at a stalemate in Congress since aid to jobless Americans and small businesses expired in July and August.

“Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses,” Powell said in the text of a speech for a virtual conference hosted by the National Association for Business Economics. “By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste.”

(Bloomberg 10/7/20)

Fed to Debate Bond-Buying Program at Future Meetings

Some U.S. central bankers sought further debate on the future of the Federal Reserve’s asset-purchase program when they met last month, signaling they’d be open to altering or increasing bond buying going forward.

Minutes of the Federal Open Market Committee’s Sept. 15-16 meeting released Wednesday showed that some participants “noted that in future meetings it would be appropriate to further assess and communicate how the committee’s asset-purchase program could best support” the Fed’s dual-mandate objectives.
Policy makers agreed at the meeting to hold rates near zero until the labor market reached maximum employment, and inflation reached 2% -- and was on track to moderately exceed that goal for some time. Forecasts also released on Sept. 16 showed officials didn’t expect the economy to reach those targets until 2023 or 2024, as it gradually recovers from the steep recession inflicted by the coronavirus pandemic.

U.S. central bankers, gathering virtually as a precaution against Covid-19, agreed to keep purchasing Treasury and mortgage-backed bonds at a combined pace of about $120 billion a month.

At upcoming meetings in November and December, officials could seek to give the economy more monetary policy support by increasing the amounts of Treasuries and mortgage-backed securities they buy in an attempt to lower borrowing costs for households and businesses.

In his virtual keynote speech before the National Association of Business Economics later this morning, Federal Reserve Chairman Jerome Powell can be expected to elaborate on the Fed’s new policy framework. And while he may also note the resilience of the US economy in its rebound so far from the depths of March, he is also likely to warn in grave tones the easiest part of the recovery is now behind us.

** More to the point, with the negotiations for the Phase IV fiscal legislation between House Speaker Nancy Pelosi and Treasury Secretary Steve Mnuchin now nearing a critical make or break moment this week, we think the Fed Chairman is likely to adopt a significantly harder edge in making the case for more fiscal policy as soon as politically possible. 

** And while it is highly doubtful Chairman Powell would publicly make an explicit link, we also think a fiscal deal this month would make it far more likely if not near certain that the Federal Open Market Committee Fed will complete its shift to a more accommodative monetary policy stance at its December meeting, with a weighting in its current asset purchases to the longer term treasuries.

Powell Spoke to Mnuchin and Pelosi

In something of a break from tradition, Chairman Powell apparently spoke with both Speaker Pelosi and Secretary Mnuchin at least once, and at length late last week. We understand it was at their request, and that the Fed Chairman was likely to have kept his remarks to laying out the argument that the economic rebound was starting to fade, and that further fiscal support was needed to bolster aggregate demand and to deter further job lay-offs going into the winter, especially with the progression of the Covid pandemic still so uncertain.

The signals drawn from Friday’s somewhat lackluster if not sobering Non-Farm Payroll report would have added to the urgency of the case Chairman Powell laid out in the phone call and is likely to later make this morning before the Nabe conference.

As we wrote earlier this week (see SGH 10/5/20, “US Fiscal: A Deal in the Crosshairs”), we believe the probabilities for an initial agreement on a new fiscal support package this week are relatively high: the headline total seems more likely than not to settle in at somewhere around $1.8 trillion to perhaps just under $2 trillion, with compromises reached on the level of support to state and municipal governments and on the scale of private sector liability protection.

And now with the President of the United States himself, as well as a dozen or more of his staff and at least three Republican Senators coming down with Covid, it would further point to a gathering political momentum behind a fiscal deal getting done this week.

But that said, the politics of Speaker Pelosi bringing along her caucus on a bill that falls short of $2 trillion, and especially for Senate Majority Leader Mitch McConnell to be confident of enough Republican support to put a fiscal bill to the Senate floor for a vote remains the wild card. But that is where the call between Chairman Powell may fit into the political calculations.

Powell’s take on the economic outlook was probably less aimed at the two lead negotiators themselves as it was to be taken back to the still sizable block of Republican Senators resisting further fiscal support, much less signing off on the $2 trillion plus scale being pressed by Speaker Pelosi and Senate Minority Leader Chuck Schumer. Likewise, the Powell implicit message to House Democrats is how critical a fiscal support package will be, even if shy of the $2 trillion mark.

Chairman Powell has assiduously courted Capitol Hill over the last few years or more, easily more so than any previous Fed chairman. He now wields considerable political goodwill as a neutral voice on the Hill. And while he certainly will not endorse any specific number or final details to a fiscal package, some of that political capital may be used in the coming days to help put a final seal on a fiscal deal.

That said, Speaker Pelosi told her conference last night the talks were proceeding “very slowly” but that she and Secretary Mnuchin will have another go by phone later today.

A More Accommodative Monetary Policy

Beyond giving a nudge to the negotiations for a fiscal deal, Chairman Powell will still have his hands full in guiding his Committee colleagues towards a next phase of the Fed’s promised transition from stabilization to monetary policy.

Likely to be dominating the internal discussions and staff work is the still sizable uncertainty around the near term base case forecasts for the economy. At one end of the spectrum is Federal Reserve Bank of Boston President Eric Rosengren with the most dire warnings of the economy slowing and potentially turning south, while Federal Reserve Bank of St. Louis President James Bullard provides a bookend to that with a very upbeat outlook for the economy in warning of upside risks to the base case outlook. Most of the Committee, including the Board, are between the two but tilted to Rosengren’s more somber prognosis.

But beyond that uncertainty over the outlook, there is an ongoing discussion over the efficacy of asset purchases, their potential transmission channels into the real economy beyond the reinforcement of forward guidance, and questions over what a prolonged period of low rates and balance sheet support to the economy might mean for financial market stability (see SGH 9/21/20, “Fed: Ok, So Now What”).

All of that is translating into a premium on policy flexibility going forward, a point highlighted by Federal Reserve Bank of Dallas President Robert Kaplan and echoed by Chicago’s Charles Evans yesterday. We think Chairman Powell may pick up on the theme as well in a few hours.. 

And to tie the Fed’s internal policy discussions to the fiscal negotiations this week, if truth be told, there is an increasing sense inside the Fed that the monetary policy stance they come to adopt will be far more muscular and effective with a sizable fiscal policy taking the lead.

And that, in turn, will have a large influence on the deliberations in coming FOMC meetings over when to go to a next stage of the transition to a more accommodative monetary policy.

Assuming a period of political volatility or a downturn in consumer confidence and spending doesn’t precede their December meeting, we still think the FOMC is more likely than not to be moving towards a next phase of more overtly accommodative monetary policy stance at their December meeting. Admittedly, though, that is a lifetime from now.

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