"Whatever We Can, for As Long as It Takes:" Fed Commits to Long-Term Dovish Policy

 | Jun 10, 2020 04:28PM ET

There you have it. The Fed stood pat today after lowering rates to essentially zero earlier this year. It expects to keep them there for a long, long time.

And in the post-meeting press conference, Fed Chair Jerome Powell didn’t exactly bury the lead, opening with the central bank’s commitment to do “whatever we can, for as long as it takes” to put the economy on solid footing.

This non-move shouldn’t be a surprise, because the futures market pointed to very low odds of any rate hike and the Fed itself has said it won’t raise rates until the economy is well along the road to improvement. In its forecast today, the Fed envisioned rates remaining near zero through 2022, so at least another two years.

What progress has the economy made, if any? That’s what many investors wanted to get the Fed’s perspective on as the central bank’s June meeting ended today. In its latest statement, the Fed said it sees gross domestic product shrinking 6.5% this year amid the ravages of COVID-19 before bouncing back with 5% growth next year and 3.5% growth in 2022. The Fed’s core inflation forecasts look pretty weak, staying below 2% through 2022.

The Fed expects unemployment to average 9.3% this year, 6.5% next year and 5.5% the year after. None of these levels would be near the “full employment” the Fed has said it wants to see on the near horizon before raising rates. Full employment is a moving target, but generally economists see it as being below 5%.

Cautious Optimism Conveyed

It’s good to see the Fed forecasting steady economic improvement over the next few years, even though pessimists might still say the Fed can’t anticipate any possible surge in the virus that might cause the economy to step back. Still, it can only work with what it knows, and as Powell has said, Fed officials aren’t medical diagnosticians.

“Financial conditions have improved, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses,” the Fed said in its statement. So apparently the stimulus and dovish policy is starting to take effect, something last week’s jobs report and some other recent economic data seemed to point toward.

Many investors also are probably scrutinizing the Fed’s language today for any sign of the central bank pressing the brakes even the slightest bit on its accommodative strategy. Worries the Fed might get less dovish surfaced after last Friday’s payrolls report revealed surprisingly strong May jobs growth. From a quick look, it doesn’t sound like any hawkish language crept in.

Stocks entered meeting time in mixed shape, with the Dow Jones Industrial Average down more than 100 points as Boeing (NYSE:BA) weakness continued, but the NASDAQ Composite still pulling at the leash amid semiconductor and Apple (NASDAQ:AAPL) strength. The S&P 500 was roughly flat. So pretty much the same pattern as yesterday.

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The market initially lost ground after the Fed decision, then traded mixed. On the one hand, it could be helpful for stocks that the Fed expects economic growth to post some decent numbers the next two years, though keep in mind that with a 6.5% decline this year, that growth will be from a lower base. That means getting back to last year’s GDP —and earnings — levels could take longer than a year or two.

The fact that the Fed isn’t forecasting any rate increases over the next two years also might be viewed as decent news, though it wasn’t unexpected. Bank stocks, however, got hit hard after the Fed meeting, as low rates tend to hit their profit margins.

Weak performance by the financial sector might be another reason the Dow is under pressure this afternoon, and the Russell 2000 (RUT) index of small caps, which is heavily exposed to regional banks, is also on the move lower.

Investors continued to roll back into bonds this afternoon, as the 10-year Treasury yield sank to 0.77%. Late last week it touched 0.9% as economic optimism percolated. If the Fed is set on keeping rates historically low for at least two more years and continue its fixed income purchases, that’s not exactly an invite to sell bonds.

Connecting the Dots

For the first time in six months, investors today got a look at a fresh Fed “dot-plot” of rate expectations. This tool provides a forecast of Fed officials’ individual expectations for the rate path over the next two to three years.

While the Fed normally releases a dot-plot once per quarter, that wasn’t the case in Q1, when the regular meeting got cancelled as the pandemic raged and the Fed pushed through two emergency rate cuts. Those rate rollbacks took the Fed funds rate down from a range of between 1.5% and 1.75% at the start of the year to between zero and 0.25% where it stands now.

So where do the dots point for 2021 and 2022?

Almost no Fed member anticipates rate hikes between now and the end of that period. In the dot plots of each members’ forecasts, only two saw a case for hiking rates in 2022. The rest see rates standing right where they are.

Going into the meeting, there were almost no expectations of any rate changes today. Instead, the focus was on what the Fed’s statement would say about the current health of the economy and how quickly growth might return.

“A full recovery is unlikely to occur until people are confident that it’s safe to engage in a wide array of activities,” Powell said in his post-meeting press conference. He added that the Fed plans to use tools like zero interest rates and asset purchases, “forcefully, proactively and aggressively until we’re confident we’re on the road to recovery. When the crisis ends, we’ll put the tools back in the box.”

Powell emphasized that the Fed doesn’t have the power to tax and spend, and said, as he has in the past, that more fiscal stimulus from Congress might be needed.

Powell called last week’s payrolls report “a welcome surprise,” adding that “we were very pleased and hope we get a lot more like it.” Still, he added, even if a number of reports like that come out, there will still be a huge number of unemployed and the Fed will need to continue providing policy support to help those people. “It’s a long road,” he said.

Ramping Up the Balance Sheet

The other question was how much more ammunition the Fed would consider firing up in its attempts to keep the economy from sliding further into the doldrums. Between March and now, the Fed’s balance sheet has risen by about $3 trillion, swelling it to more than $7 trillion. That’s way above the previous peak of $4.5 trillion in early 2015 following the financial crisis.

In its statement, the Fed restated its commitment to continuing to increase its bond holdings, with Treasury purchases of $80 billion a month and mortgage-backed securities of $40 billion. This, Powell said in his press conference, will help sustain orderly market conditions.

Some economists worry that the higher balance sheet—accompanied by fiscal stimulus from Congress and the White House that also went through this year—could trigger inflation at some point, though Powell has said inflation isn’t really a worry of his now. Today’s consumer price index (CPI) reading for May of negative-0.1% revealed a very quiet inflationary picture, which isn’t surprising considering the high unemployment rate. The annual “core” CPI is up just 1.2%.

With inflation looking so weak long-term, Powell quipped, “we’re not thinking about raising interest rates or even thinking about thinking about raising rates.”