FOMC and Chairman Powell: Doing the Covid limbo

• Fed rates and policy unchanged as widely expected.
• Powell warns of economic slowdown from rising virus caseload.
• No mention of expanding bond purchases to yield curve control.
• Dollar and Treasury rates fall, equities rise, erasing pandemic loss.

The Federal Reserve kept its policy and rate matrix unchanged at the July meeting while Chairman Powell warned that a slowing economy would require support for the foreseeable future.

There had been little market expectation for any substantial change to the central bank’s approach to the economic consequences of the coronavirus pandemic that has remained largely unaltered since its two emergency meeting in March.

In the FOMC statement the governors noted that “economic activity and employment have picked up somewhat in recent months but remain well below their levels at the beginning of the year.”

The bank cut its benchmark rate to 0.25% at the beginning of the US epidemic, instituted a new quantitative easing program to cap interest rates and began offering loans to business and local governments in need of assistance.  That program has been far less utilized than expected with about $110 billon of $484 billion authorized by Congress extended.

“We have not done as much lending as we thought but that is primarily because markets began to function again,” noted Mr. Powell in his news conference.

Mortgage rates have responded to the Fed’s initiatives with the average cost of a 30-mortgage setting an all-time low of 2.87% recently.

Euro response

Markets initially took the dollar lower with the euro crossing 1.1800 for the first time since September 2018 but the foray was brief and the euro settled to 1.1791 at the close.

The united currency has gained 4% against the dollar in the last two week as markets have anticipated that the potential slowing recovery will force the Fed into further rate liberalizations, perhaps at the longer end of the yield curve.

The USD/JPY dropped below 105.00 for the first time since the market panic in March closing at 104.96. 

Slowing US economy

Chairman Powell said that high-frequency data such as credit card purchases, travel, restaurants visits and the like suggested that the  US economy began to slow  after virus cases began to accumulate in early June though whether that would continue is uncertain.

The FOMC statement and Mr. Powell noted that progress on the economy is closely linked to the control of the virus.  “A full recovery is unlikely until people believe it is safe to undertake a full range of activity,” said the Chairman.

Credit markets

Treasury rates moved lower as Mr. Powell indicated that the economy would likely need the support of low rates for a considerable time. The 10-year Treasury lost four points form it open to finish at 0.577%. The 2-year lost one point to 0.133%.

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Equities

Stocks had the best response to the prospect of low rates for the foreseeable future. The S&P 500 rose 1.24% to 3,258.44 and the Dow jumped 160.29 points to 26,539.57.  Equites have now erased all of their pandemic losses though the Dow remain about 10% below its all-time high.

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Conclusion

The Fed is fully engaged in the fight against the economic weakness stemming from the Covid pandemic and though the Chairman did not directly mention expanding its rate impact to the longer end of the yield curve, its commitment to providing as much support as possible leads in that direction.

As long as the US economy fails to achieve a robust self-sustaining recovery, whatever the reason, speculation on lower rates will continue to support stocks and bond prices and weaken the dollar.