Fed to Debate Dimming Outlook as Virus Surges, Fiscal Help Hangs

(Bloomberg) -- For Federal Reserve officials, as for many others, it’s been a long six weeks.

Setbacks in the fight against the coronavirus will push Fed Chair Jerome Powell to reinforce his dovish message this week that interest rates will stay near zero for a long while. That said, policy makers probably won’t adopt a shift in strategy at their July 28-29 meeting, even as they review how the outlook has changed.

When the U.S. central bank’s top policy-making body last met in early June, the country’s daily count of new coronavirus cases had stabilized, with states like New York and New Jersey logging declines and others like Texas, Florida and California yet to see the surges that have afflicted them since.

Even so, the outlook for the economy Powell and his colleagues presented to the public was grim. A strong projected rebound in the third quarter wouldn’t be anywhere near enough to bring unemployment down from recessionary levels for years to come.

Now, with the U.S. in the grips of a resurgent outbreak, even the strong third-quarter rebound is in doubt. High-frequency economic indicators are pointing to a slowdown, which will only serve to reinforce the Federal Open Market Committee’s dovish guidance when it meets again this week.

Momentum Sapped

“We had a decent amount of momentum going into the third quarter, and a lot of that momentum has been sapped,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York. “You can see the slowing right as the case counts really started to rise, and the Fed is going to be acutely aware of what happened.”

U.S. central bankers have primarily been pondering two things in recent months, according to the records of their April and June policy meetings.

The first is whether the economy would gradually recover throughout the rest of 2020 from the sharp contraction in the second quarter, or whether a second wave of coronavirus outbreaks later in the year would put that rebound on ice. Fed staff economists had been advising policy makers that, given the extraordinary degree of uncertainty, both scenarios were equally plausible.

That question has loomed large over the second order of business, which is how the Fed can make sure it doesn’t repeat the mistake of withdrawing the support low interest rates provide the economy before it achieves its congressionally mandated goals of full employment and stable prices.

Fed watchers expect policy makers to continue debating strategy at this week’s meeting and settle on a new approach at their next gathering in September, in which they would pledge to keep the central bank’s benchmark rate where it is now, near zero, until certain thresholds for inflation and unemployment have been met.

Forward Guidance

The hope is that such a strong message from the Fed about its intentions would keep a lid on longer-term interest rates for the foreseeable future, fostering easy borrowing conditions in financial markets and, in turn, stronger economic growth.

But the renewed slowdown in recent weeks means policy makers have some more time to work the strategy out in detail because “no one thinks for a second” that rate hikes are on the table anytime soon, Porcelli said.

Powell went as far as to say in June that the Fed wasn’t “even thinking about thinking about” raising rates.

More important for the economy at this juncture is the decision lawmakers in Congress will make about another fiscal relief package for households and businesses -- on top of the roughly $3 trillion in aid that’s been authorized so far -- which is currently being debated and expected to be finalized in early August.

The fate of enhanced unemployment insurance benefits, which were part of the package Congress passed in March and have been critical for keeping growth in household incomes steady since then, is at the top of the agenda.

Not far behind is aid for state and local governments, which have seen tax revenues plunge amid the pandemic and, as a result, were forced to lay off about 1.5 million workers in the second quarter.

Partisan Debate

Powell and other Fed officials have repeatedly emphasized the importance of government spending for getting the economy through the pandemic intact, while avoiding wading into a partisan debate over the parameters of aid. They will probably drive the point home again this week, according to Neil Dutta, head of economics at Renaissance Macro Research in New York.

“That’s a way for Powell to talk about it: ‘We can deal with the issues of liquidity, market functioning, helping ease financial conditions, and things like that. But issues of solvency and economic growth and public health, those are issues that have to be addressed by fiscal policy,’” Dutta said.

“He can say something like, ‘Because state and local governments are on the front lines of this, they should be singled out for support,’” Dutta added. “That, to me, is a way to say it that doesn’t rattle too many cages.”

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