The Federal Open Market Committee meets Wednesday for the last time before the US presidential election – and the first time since it has embraced a new monetary strategy that will be more tolerant of higher inflation and more committed to promoting full employment .
The US economy is still grappling with the Covid-19 pandemic shock and with less fiscal support on the horizon, Jay Powell, the chairman of the Federal Reserve and other officials will need to consider what additional support they can offer for the recovery.
Here are five things to watch:
A rosier forecast, with warnings
Fed officials are expected to produce a series of rosier economic projections for this year than in June.
The unemployment rate has already fallen to 8.4 percent, well below the Fed̵
Meanwhile, production is expected to decline by less than the 6.5% this year predicted by US central bankers three months ago.
The improvements reflect a better-than-expected performance for the economy as it faced infection spikes over the summer. But the long-term projections may attract more attention, as they will extend to the end of 2023.
Fed officials will expect U.S. interest rates to remain at zero until then, especially given their ultra-dovish strategy change announced last month, which allows them to let inflation outperform their target. 2% before tightening the policy? And will their inflation forecasts show overshoot?
The Fed’s view is still that the US faces a long and challenging recovery and that there are major risks ahead. The coronavirus path during autumn and winter, as it intersects with seasonal flu, is unclear; the new fiscal support for the economy is highly debated; and the upcoming US elections could be destabilizing if they yield an uncertain outcome.
The tax alarm sounds
Mr. Powell – and other Fed officials – have made it clear that they would like Congress and the White House to agree on a new aid package to support the recovery. But having been ignored so far by the Trump administration and Capitol Hill lawmakers, how much will the Fed president go to haranguing them for their inability to act?
The Fed fears that the lack of a fiscal deal threatens the recovery and will make its job more difficult. The US central bank does not want to be left alone to support the recovery.
The Fed also admitted that it does not have the tools to solve all the problems of the economy, as it can only lend money, but not spend it on helping businesses or households. And the Fed is well aware that its policies have done a lot to save financial markets from suffering, but it cannot offer benefits to low-income families and the unemployed as easily.
New guide for a new era
After the Fed made its historic announcement last month that it would tolerate higher inflation, investors wondered how such a policy would work in practice. Fed officials past and present have since lent their backing to the new monetary framework, but there have been few details on what action should be taken and when.
A potential tool that has attracted the attention of both market participants and FOMC members is a more explicit form of future orientation. This would involve the Fed tying interest rate adjustments to specific economic parameters such as the unemployment rate or inflation.
One sentence in the FOMC statement to watch is if the central bank changes its commitment to keep rates close to zero “until it is sure the economy has withstood recent events” into something more solid.
Another is whether the Fed will deliver on its promise to evaluate economic conditions against its “maximum employment target and its symmetrical 2% inflation target”. Some economists have suggested that the Fed might modify this to include a reference to an average inflation target of 2% “over time”, reflecting its new policy framework.
Investors claiming the new guidance is being launched this week say the Fed risks a loss of credibility if it doesn’t act quickly to strengthen its monetary shift.
A move on bond buying
Fed Governor Lael Brainard said this month that it will soon be important for “monetary policy to move from stabilization to accommodation” as the economic recovery proceeds in fits and starts.
Investors expect this philosophy to eventually apply to the US central bank’s bond purchase program, which currently plans to raise $ 80 billion of all-maturity Treasuries each month. The Fed has defined these purchases as necessary to ensure the smooth functioning of the financial markets – a point it has consistently emphasized since March, when trading conditions in the world’s largest public debt market froze.
The issue facing the Fed is how long the debt it buys. As the federal government borrowed more, the Treasury shifted most of its issues from bills maturing in a year or less to longer-term debt. Many strategists are now calling for a corresponding move in Fed buying to ensure financial conditions remain loose.
Finding space on Main Street
The Fed has generally gained acclaim for launching a series of emergency credit lines at the start of the pandemic that stabilized and then sustained financial markets.
But there is one exception. The Main Street Lending Program – set up to help midsize businesses – has attracted few customers. Critics believe its loan terms are too strict. Distressed sectors such as commercial real estate feel excluded.
Mr. Powell may wonder if he is willing to revise the program to make it more attractive, which would involve taking more credit risks together with the Treasury.
“We don’t think the Fed will capitulate to all the demands of the industry and lawmakers, but we expect it will continue to look for ways in the coming weeks to expand and flexibilize Main Street to get help for more companies,” said Ian Katz, a policy analyst. at Capital Alpha, in a recent note.
If the Main Street facility is seen as a flop, Congress could divert the money allocated to it for other purposes – a prospect that Mr. Powell may want to reject.