Powell Speech: Another chapter of policy?

May 13, 2020

Today, the Chairman of the Federal Reserve (Fed), Jerome Powell, struck an ominous tone regarding the shape of the US economy, which has been sent into a tail-spin by anti-virus measures.

So far, 16 million people have lost their jobs amidst the pandemic and the unemployment rate rose by 10.3% to 14.7% in April – the highest level since World War 2. Lower income workers have been the hardest hit with their exit from the labour market artificially inflating wage growth numbers; average hourly earnings climbed 7.9% from a year ago.

In a bid to soften the economic blow, since mid-March, the Fed has already cut its key interest rate to near zero and purchased more than $2 trillion in Treasury bonds and mortgage-backed securities to allay fears that were beginning to cripple financial markets. Today, Powell said that this “may not be the final chapter [for policy], given that the path ahead is both highly uncertain and subject to significant downside risks.”

The fear is that the fabled V-shaped recovery is now looking like a long shot, with the general recognition that a return to normal is going to be a protracted process. Indeed, our base case sees a “check mark” shaped trajectory – a fast drop in activity followed by a slow march up again. Powell warned that “deeper and longer recessions” tend to leave “lasting damage to the productive capacity of the economy”. In light of this, the Fed will continue to use its tools “to their fullest until the crisis has passed and the economic recovery is well under way”.

But monetary policy will have to be galvanized by fiscal support. Powell called for this again in saying:

Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery. This trade-off is one for our elected representatives, who wield powers of taxation and spending.”

On the fiscal side, on the heels of a 3-trillion-dollar package, the Democrats have released plans for a second $3tn stimulus plan that includes roughly $875bn in aid for state and local governments. This was quickly rejected by Republicans and it is not clear if it will pass the Senate.

The result of war-time fiscal packages is going to be unprecedented debt. This in turn likely means that rates are going to stay lower for even longer. Already, Trump is advocating for negative rates, despite limited evidence of their efficacy in Japan and Europe. On Tuesday, he tweeted:

“As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the ‘GIFT’”.

However, the Fed does not yet seem to be headed in such a direction – Powell previously pointed out that negative rates hurt banks and ultimately their ability to provide credit to the real economy.

Hopefully, with lockdowns slowly lifting across the US, May will mark the nadir in economic data. But, the fear, as Powell himself stressed is that the “recovery may take some time to gather momentum, and the passage of time can turn liquidity problems into solvency problems”. Powell is scheduled to speak again on May 19th in a Congressional testimony and the next FOMC meeting is scheduled for June 9-10th.

Author: Group Investment Office