Federal Reserve tacks between hope and uncertainty: But let’s keep those rates low

The Federal Reserve finally put numbers to the events and policies of the past three months issuing its delayed projection materials, forecasting that the US economy will contract 6.5% this year and unemployment will be 9.3% in December.

Fed governors also have no expectations of raising interest rates through the end of 2022 and that inflation will fail to meet its 2% target.

In his press conference Chairman Jerome Powell steered a close course between optimism and realism.  He noted in one response that, "the evidence of the jobs report is that the labor market may have hit bottom in May," while later acknowledging that many millions may not get their old jobs back.  The conference was virtual with Mr. Powell at a podium on camera while the reporters were on links from their homes or offices.

The most telling testimony to the uncertainty of the economic future was in the projection materials themselves. While the bank sees no alteration in the 0.25% fed funds rate for three years, the longer run unemployment rate, beyond 2022, is 4.1%, the same as it was in the last set of projections from December before the coronavirus crashed into the economy.

Mr. Powell said the Fed intended “to do whatever we can for as long as it takes” to bring the economy through the crisis brought on by the pandemic.

“Back two months we had the tightest labor market in a quarter century and wages were going up for the lower paid end of the labor market. We would like to get back to that place”

Market reaction

Equities initially rallied after the policy statement and projections were released at 2 pm but stocks later moved lower with the S&P 500 closing off 17 points, 0.53% to 3190.14. 

The dollar moved lower against the majors, losing more than a figure against the euro and breaking above 1.1400 for the first time since March 10 and the height of the coronavirus panic. Versus the yen the dollar dropped below 107.00 having opened the week at 109.59.

Treasury yields droppedwith the 10-year losing eight pointsto 0.7480% and the 2-year shedding three to 0.1790%

Dot plot

The projections showed that all 17 officials who contribute to the FOMC thought that rates would be unchanged in 2021 and 15 of them expected that to remain true in 2022.

As Mr. Powell said, We’re not thinking about raising rate. We are not even thinking about thinking about raising rates.”

Unemployment is forecast to drop to 6.5% in 2021 and 5.5% in 2022 with most participants putting the rate at the end of this year between 9% and 10%. 

The unemployment estimate for the longer run, after 2022 of 4.1% unchanged from the December projections suggests that the Fed sees the full recovery as taking three years.

Economic growth is projected to bounce back to 5% in 2021 and 3.5% in 2022 with the longer run at 1.8%. The range of the estimates for contraction this year were between 4% and 10% with one official predicting 1% contraction next year.

Fed and government response

Mr. Powell said that, “a shock like this is like a natural disaster. You don’t want a lot of small businesses who may not have a lot resources, to go out of business.” He praised the government and central bank’s responses.

“The May employment report was probably the biggest surprise anyone can remember,” he noted, but it leaves nearly 20 million fewer Americans employed than in February.  “It could be some years before we get back to those people finding jobs.”

The Fed cut rates 1.5% in the first two weeks of March before any of the job losses began to show up in the unemployment claims figures and instituted bond purchases to forces rates lower and began a $2.3 trillion small business and government loan program. The Trump administration and Congress approved $3 trillion in various support and stimulus programs. 

Referring to the Fed program Mr. Powell observed “Its big. The question is will it be [the stimulus] big enough. It possible we will need to do more. It is possible Congress will need to do more.”