This week the Federal Reserve Open Market Committee (FOMC) published minutes from their July 2020 meeting. For Fed watchers, this is an important moment, quenching their thirst for fresh insights. They want the Fed to be explicit around the economic outlook, forward guidance and policy, i.e. when will the Fed adjust interest rates? However, Central bankers tend to be nuanced, careful about what they say and often leave room for doubt. They work with ranges and scenarios.
Chairman Jay Powell is playing the long game, strategic and tactical, refusing to be backed into a corner. He knows the current environment is fast-moving and the outlook can change in a heartbeat.
At this stage of the economic recovery, markets are thinking ‘where do we go from here?’. The shape of recovery is no longer contentious with Central bank actions integral to the formation of a bridge to a ‘V’ shaped economic rebound in the US. There is a lot of work still to be done.
As we know, interest rates are currently at historically low levels, and purchases of government and corporate bonds have been stepped up again, providing much-needed liquidity. Their backstop in the early stages of the pandemic prevented worst-case scenarios developing. High-level support is ongoing.
The FOMC minutes confirmed interest rates in the US would remain within their target range of 0 – 0.25%, but what about their reasoning? How has this evolved?
The minutes expand on policy practices. They are heavily scrutinised for any change in tone or guidance. The key points include:
- Transparency and accountability of monetary policy will facilitate well-informed decision making by households and business.
- Acknowledgement that yield curve control would have limited benefit in an already low-interest rate environment.
- Recovery remains dependent on the course of the virus and the public sector’s response to it.
Notwithstanding these caveats, the Fed are willing to use their full range of tools to support the US economy. The Central bank is hoping transparency around its actions now will encourage business and household to have greater confidence to spend/invest in the future.
The minutes leave no room for doubt that the Fed members are determined to meet their objectives of maximum employment and inflation at 2.0%.
What next?
One must acknowledge the challenge the Fed face at present. The pace of developments surrounding the sudden onset of Covid-19 and collapse in economic activity means traditional backwards-looking indicators no longer provide the clarity required for immediate policy decisions. Shifting to examining higher frequency data points is a sign that they are seeking information that gives a more intuitive feel to the recovery as it unfolds. They are looking for early signs of relapses or upward shifts in behaviour and activity.
Using the charts below, we start with a picture of the virus in the US, thankfully improving. We then show various traditional data points the FOMC consider when taking the pulse of the economy, before finishing our analysis with a high-frequency data point chart. This is a new way of looking at activity in the here and now.
Chart 1.0 – New Daily Covid-19 cases March – August 2020 (thousands, 1-week average): Evidence of success in containing the virus in the US sunbelt regions is now evident. Local government is now more educated on the measures needed to contain the virus (chart 1.0).
Source: Oxford Economics, August 2020
Chart 2.0 -US Retail Sales: A traditional measure showing retail purchases rebounding to above pre-pandemic levels and displaying a classic ‘V-shaped’ recovery.
Source: Bloomberg, August 2020
Chart 3.0 – Industrial Production and Capacity Utilisation: Traditional measures showing industrial production picking up and manufacturers operating at a greater level of capacity, i.e. manufacturing more goods. This means factories are getting up to speed.
Source: Oxford Economics, August 2020
Chart 4.0 – ISM Purchasing Manager Indices (PMI): Indices are above 50 demonstrating expansion and confidence in the outlook returning. The goods being manufactured are being purchased.
Source: Bloomberg, August 2020
Chart 5.0 – Federal Reserve Bank of New York Weekly Economic Index (WEI): This high-frequency index is designed by the Federal Reserve Bank of New York. It measures a range of indicators to gain context on consumer behaviour, the labour market and production. These signals have continued to improve BUT as the fiscal support to households from the CARES Act fades and benefit cheques stop, the risks go up. Therefore, a new fiscal stimulus package is important.
Source: Federal Reserve Bank of New York, August 2020
Conclusions:
- The path to economic recovery remains sensitive to COVID-19 case data and the public response to the data.
- The Fed remains committed to using their full armoury to support the economy and remain wary when giving forward guidance given the speed of change.
- Improvement in activity is evident across the US; however, a second fiscal stimulus package to fill the void after the CARE’s Act expires is required to maintain momentum.
