Three issues are likely to dominate the Federal Open Market Committee discussions at their July 28-29 meeting next week: an assessment of the 13-3 credit support facilities; further work towards a consensus on revisions to the broad policy framework and near term monetary policy at the zero lower bound, and; the deteriorating near term economic outlook.
Working from back to front, we would make these points as prologue to the likely July FOMC meeting takeaways:
“A Swoosh Written With a Shaky Hand”
Federal Reserve Bank of Philadelphia President Patrick Harker caught our attention with the poetic phrasing above in describing what we think is a solidifying Committee consensus view going into next week’s meeting on a stalling rebound in the economy.
Nearly every public remark by Fed officials in the weeks before the current pre-meeting black out cited “considerable risks” or “extraordinary uncertainty” and referred repeatedly to the rising risks of “economic scarring” in the wake of the renewed waves of the virus outbreaks undermining the strength of the rebound.
The fears shared across the Committee to varying degrees is of the choppy stop-starts to re-openings that is undermining the pace of the recovery, or worse, potentially leading to prolonged shutdowns that would deepen the flattening in consumption and investment spending. Hysteresis of the labor market is a word that often crops up in discussions.
“Ideally, we would have followed the path of many other countries in Asia and in Europe and gotten the pandemic under control so that we could open safely, one District Fed president sighed in an interview just before the black-out. “That has not been the outcome that we’ve actually experienced. So that means that I have a more dire outcome.”
All of these remarks and some softening in the data are pointing to markdowns in the economic forecast used as the basis for the July meeting discussions, which are being wrapped up this week. While there won’t be published Summary of Economic Projections at the July meeting, our sense is that narrowed median of the forecasts for the meeting are converging towards the more pessimistic end of the ranges by all 17 Committee members for real growth and unemployment in the June meeting.
The largesse of the three fiscal spending programs enacted by Congress since mid-March has been crucial in preventing a deep income shock to the economy while the Fed’s rush to introduce the 13-3 credit facilities stemmed what could have been a hugely negative credit feedback loop.
The FOMC had been hoping there would be more clarity on the next round of fiscal policy support by the time they meet next week – any further fiscal measures may prove elusive after this one until next year – but they will now have to work with wider range of forecasts on the fiscal support to the economy and then wait until the September meeting for a clearer and cleaner sense of how much fiscal boost to aggregate demand will be underpinning aggregate demand.
All that said, the bounce back in consumer spending so far looks to have tapered but not reversed, at least not yet. And even the more dire scenarios for the economy in the near term are not even close to a repeat of the unprecedented collapse of March. In that light, a recovery merely stalling rather than nosediving will look and feel downright upbeat. And that should leave some room for upbeat remarks by Chairman Jerome Powell to wash over the more cautious outlook the Committee will be weighing during the two days of discussions next week.
Likewise, the inevitable handwringing and anxieties across the Fed over the implications of lower trend growth or higher longer run unemployment estimates, or a still falling r*, can be pushed back into September. July would be too early for those concerns to make it to the forefront of the discussions, but it may all come into play in setting the mood music around the deliberations over the ongoing revamp to the Fed’s longer run policy framework.
Edging to a Policy Framework Consensus
At one point we were fairly optimistic the FOMC could wrap up their work on the policy framework at the July meeting. Underway for more than a year, the rethink on the policy framework, built around revisions to the annual “Statement of Longer Run Goals and Monetary Policy Strategy” is meant to provide a consensus “constitutional” statement of the FOMC’s general principles guiding monetary policy.
We have written previously on the likely tweaks we think will eventually come to the longer run statement (for instance, see SGH 5/19/20, “Fed: On the Transition to Monetary Policy,” and SGH 7/1/20, “Fed: More on the Monetary Policy Transition”). When unveiled, it will primarily underscore the Fed’s determination to lift inflation back to mandate consistent levels, namely, with language that will affirm a willingness to engineer, not merely tolerate, an overshoot of the symmetrical 2% inflation target.
But a consensus on the final language changes to the longer run statement still feels elusive, so we would be pleasantly impressed if the FOMC unveiled a consensus document next week.
Our sense is that two issues still remain even if consensus has converged around inflation averaging language: how to phrase the references to maximum employment, for one, whether to still include a specific longer run estimate for unemployment or whether the Committee may opt for more general language underscoring policy to drive employment as high and as broadly as possible, and; we understood there was also still some debate over whether to harden the statement’s reference to financial stability as an “escape clause” to what will otherwise be a remarkably dovish constitutional document.
Instead we suspect the July meeting Minutes will be a better barometer of the Committee progress, and for what is now looking to be a revised longer run statement in September coupled to the outcome-based lower for longer forward rates guidance, reinforced with a commitment to open-ended large scale asset purchases.
And our sense is that here too, consensus is lacking and may take more time. For instance, there is still the exact structure of the thresholds to be worked out: outcome-based rather than date-contingent thresholds seem likely, that include both inflation and unemployment thresholds, but it appears that the exact wording and the relationship between the two thresholds, if for instance pointing in opposite directions, is still far from resolved, while the tension between policy flexibility and credibility likewise still needs to be ironed out.
And it is probably worth noting that for now, we suspect Chairman Powell is more likely than not to offer some markers on the progress in the eventual transition to monetary policy, but will otherwise again affirm the FOMC feels no particular rush to finalize its framework or a new policy playbook at the zero lower bound.
After all, it would be hard to find anyone who assumes the Fed is going to be raising rates any time soon or is “even thinking of” raising rates. Financial conditions are in fact as easy as they ever have been in the last decade.
So September still seems a safe earliest target date to unveil the new monetary policy to provide a long run of accommodation. Hopefully by then, the economy will be gaining enough of a sustained traction to ensure a transmission of additional policy easing beyond the “pre-positioned” accommodation of the rate cuts, steady state of asset purchases, and the 13-3 credit facilities since March.
The 13-3 “Insurance”
And finally, a third issue that will take up a considerable chunk of the two days of deliberations will be a progress report and assessment of the 13.3 credit support facilities offered jointly by the Fed and Treasury. To date, while the take down across the facilities has been limited, Fed officials are reasonably satisfied with the success of the extraordinary interventions since March, with market function all but back in place, indeed there has been record levels of debt issuance and a soaring stock market.
The initial round of the 13-3 facilities have an end-date of September 30, but they are certain to be extended – albeit the decisions on any changes to the terms, for how long, and the exact nature of the coordination between Treasury and the Fed are likely to be a subject of immense importance at the September meeting.
In the meantime, most Fed officials see the 13-3 facilities as an “insurance” buffer against a repeat turn south in the economy that could see a rapid scaling up in the demand across the 13-3 facilities, including the Main Street Lending Facility that is only now starting to get underway. It is a point made by Federal Reserve Bank of Boston President Eric Rosengren – whose district bank is overseeing the MSLF – who sounded somewhat resigned to a significant pick up in the demand for the MSLF later this year if the economic rebound weakens to the extent he fears is possible, if not probable.
Finally, perhaps more interesting when set against the framework debate, Rosengren added that if economic activity does indeed seriously slip south, the 13-3 facilities like the MSLF or the Municipal Lending Facility could even become primary policy tools to support the economy. That prospect must be lingering in the backs of the minds of the FOMC members eyeing the economic and fiscal policy developments in the coming months.