(Bloomberg) — It sounded a bit like a broken record.
Confronted by a pandemic that has devastated the economy, Federal Reserve Chair Jerome Powell declared no less than 10 times last week that the central bank has a “powerful” new monetary policy road map for returning the U.S. to full employment and lifting inflation temporarily above 2%.
“It was powerful,” Mellon chief economist Vincent Reinhart said wryly of the central bank’s plan for continued rock-bottom interest rates. “If you say it 10 times it must be so.”
Such skepticism, which was partly reflected in falling stock prices toward the end of last week, could prove to be a headwind for the Fed. If consumers and companies doubt its ability to achieve its aims, they’re likely to be more risk averse, holding back the economy in the process.
To counteract that, more specific policy commitments by the Fed, including when it comes to its asset purchases, and increased help from Congress on fiscal policy, may be needed.
The Fed said it expects to hold interest rates near zero until the labor market has reached maximum employment and inflation has hit 2% and is on track to moderately exceed that for some time. Policy makers also predicted that rates will stay near zero at least through 2023, the last year of the Fed’s forecasting horizon.
“It’s a very substantial step forward,” said David Wilcox of the Peterson Institute for International Economics. “It was one of the few remaining arrows in the Fed’s quiver to pull out.”
In a Sept. 16 press conference, Powell acknowledged that the new monetary message was unlikely to have “a big reaction right now” and said the Fed could probably use some more help from Congress in resuscitating the economy from the damage done by Covid-19.
Fiscal Support
“More fiscal support is likely to be needed,” he said. “There are still roughly 11 million people out of work due to the pandemic.”
So far, Americans have drawn on their savings to tide themselves over in the absence of further government aid. But there’s only so long than can last.
The delay in stimulus will contribute to a steep slowdown in growth from 25% in the third quarter to a “low- to mid-single-digit” rate in the fourth, Barclays Plc chief U.S. economist Michael Gapen told Bloomberg Radio and Television on Sept. 17.
Even after the coronavirus crisis has passed, the Fed faces a longer-run obstacle to its management of the economy — what Powell terms a “new normal” of low inflation, low interest rates and slow growth. It’s a dangerous world where economies are more prone to fall into the kind of deflationary malaise that has plagued Japan off and on for decades.
Powell repeatedly argued last week that the new monetary blueprint would succeed in pushing inflation higher after years in which it’s largely run under target. “This very strong, very powerful guidance shows both our confidence and our determination” to achieving that goal, he said.
Some investors and economists are not as optimistic, despite signs the U.S. is making more progress toward price gains than other nations. The forces holding down inflation — globalization, automation, aging societies — are strong. Just look at Japan. In September 2016, the Bank of Japan pledged to maintain an ultra-loose monetary policy until inflation rose above 2%. That never happened.
“We are now in the same position Japan was years ago — with the target — but we don’t really have the ability to hit it,” said Nick Maroutsos, head of global bonds at Janus Henderson Investors.
More Discretion
What’s more, the Fed’s updated framework gives it a lot of leeway in meeting its average 2% inflation target. While that flexibility could prove valuable in steering the economy, it raises questions about how serious the Fed would be in pursuing that goal should other events intervene.
“Powell was selling the sizzle,” said Wrightson ICAP chief economist Lou Crandall. “But they went for the softest version of average inflation targeting that they could.”
Minneapolis Fed President Neel Kashkari, who voted against the new rate guidance, said it leaves the door open to premature tightening of monetary policy again and should be replaced with a stronger commitment to achieve the Fed’s goals.
One area where Powell has been convincing was on the outlook for rates: investors see no prospect for a rate increase for the next three years, according to pricing in federal funds futures markets.
No Formula Here
The Fed said it would aim for inflation rising moderately and temporarily above 2% to make up for past shortfalls, without saying by how much or for how long. When pressed at the press conference to be more specific, Powell declined to do so. “We’re resisting the urge to try to create some sort of a rule or a formula here. And I think the public will understand pretty well what we want,” he said.
Maybe so, but bond market investors for their part aren’t buying it. Even after the roll-out of the Fed’s new rate road map, they see consumer price inflation averaging 1.7% over the next 10 years, based on trading in Treasury inflation-protected securities.
Some investors were also disappointed that the Fed did not lay out longer-run program for purchases of Treasury and mortgage-backed securities — so-called quantitative easing. Instead, it reiterated it will continue buying those securities “at least at the current pace” over coming months.
“It is a little telling that Powell had to go to such lengths to say how powerful” the new guidance was, said Derek Tang, an economist at LH Meyer/Monetary Policy Analytics in Washington. “It is fair to ask: What is different about what you are actually doing?”
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