US: Powell’s cautionary tale

Chairman Powell’s semi-annual monetary policy testimony to the Senate reinforces the view that while the Fed is encouraged about the recent data flow as the economy re-opens, we are a long way from “normality” and that won’t arrive there is confidence we have overcome Covid-19.

While economic indicators “have pointed to stabilisation, and in some areas a modest rebound”, the levels of output and employment remain “far below” their pre-pandemic levels. He highlighted the uncertainty over the economic outlook and reminded his politician audience that “the longer the downturn lasts, the greater the potential for longer-term damage”, citing persistent unemployment as a key fear.

In this regard he again placed great emphasis on inequality, pointing out that “those least able to withstand the downturn have been affected most” with minorities, women and low-income households disproportionately carrying the burden of the economic hardship.

He again, tries to provide a reality check to the optimism in risk markets, such as equities, which are seemingly seeing only good things ahead. He warned of the risk of insolvencies, particularly in the small business sector and suggested that “until the public is confident that the disease is contained, a full recovery is unlikely”. Given a vaccine appears some way off and fears over a pick-up in Covid-19 cases in several states, he is clearly sitting on the more cautious side of the fence.

Inflation (nor deflation) is not a concern for the Fed, with long-term inflation expectations having remained stable despite sharp price falls in some components (apparel, gasoline, air travel, etc) and sharp rises in food over the past couple of months. Nonetheless, on balance, inflation is “likely to remain below our objective for some time”. We certainly agree given mass unemployment will keep wage pressures benign with the widening output gap further depressing price pressures.

Given the scale of the downturn and the lack of inflation threat the Fed remains committed to keeping the Fed funds rate at the 0-0.25% level “until we are confident that the economy has weathered recent events and is on track to achieve our maximum-employment and price-stability goals”. He was asked about yield curve control, but his response was merely that discussions were at an “early stage”. With the 2Y anchored at 0.2% and the 10Y at just 0.7% we see little need unless rising treasury issuance was to put upward pressure on borrowing costs that would translate into tighter credit conditions in the broader economy.