One of the fastest Covid-19 vaccination campaigns in the world has enabled US states and cities to rapidly ease lockdown measures, adding momentum to a hiring spree that has accompanied the sharp rebound in consumer spending and other business activity.
But will the Federal Reserve waver from its ultra-accommodative monetary policy?
Here are four things to watch on Wednesday when the Federal Open Market Committee wraps up its latest policy meeting and chair Jay Powell addresses his regular press conference.
An economic ‘inflection point’
Since Fed officials last convened in March, evidence has mounted that the US economy is on much firmer footing than at the start of the year. In fact, Powell said earlier this month it was at an “inflection point”.
Vincent Reinhart, a former Fed economist who now serves as chief economist at Mellon, said Powell would be careful not to overstate the improvements, however, in order to avoid any premature conversations about the US central bank’s plans to eventually begin the process of withdrawing its policy support.
“He has to admit that economic growth is in the process of picking up in a way that will erode labour market slack and will probably add a bit to inflation,” he said. “But from Jay Powell’s perspective, the unemployment rate is still too high . . . He both has to say, yes, it is a rebound but it is not yet a recovery.”
Substantial further progress?
The rebound has heaped pressure on the Fed to clarify how much more ground must be gained before it begins to rethink a pillar of its monetary support for the US economy, namely its monthly purchases of $120bn of government securities.
Top officials have demurred from offering any specifics, instead repeating that this level of bond buying will continue until the Fed sees “substantial further progress” towards a more inclusive recovery and inflation averaging above its target of 2 per cent.
No talk of tapering purchases is expected at this meeting, given that the unemployment rate is still elevated at 6 per cent and consumer prices as measured by the Fed’s favourite gauge — the core personal consumption expenditures (PCE) price index — are in check at 1.4 per cent. But investors are looking for any guidance from Powell about when those conversations may kick off.
Economists at Goldman Sachs reckon the Fed will start hinting about its eventual withdrawal in the second half of this year in order to begin tapering in early 2022.
An even stronger labour market recovery — with 1m or more jobs added a month — could accelerate this timeline, according to Aneta Markowska, chief economist at Jefferies.
“If anything, we believe the odds are skewed toward faster progress,” she said. That may mean initial tapering discussions as early as June.
Just months after Joe Biden’s administration passed a $1.9tn coronavirus relief bill, policymakers are debating yet another massive injection of government spending. The $2tn infrastructure proposal, which Biden said would “create the strongest, most resilient, innovative economy in the world”, is set to be funded in part by higher taxes for corporations and wealthy individuals.
Powell may face questions about the impact of these plans on the Fed’s outlook and policy path.
“Increases in corporate taxes may put a damper on the market and inflation may not be as buoyant as people thought,” said David Norris, head of US credit at TwentyFour Asset Management.
The Fed is also paying close attention to very short-term interest rates, which have been sinking since the start of the year as reserves in the financial system have ballooned.
The central bank has been clear that it does not want any market interest rates to go negative, with knock-on consequences throughout the system, which is why it has set its main policy rate, the federal funds rate, in a target range of 0-0.25 per cent. Currently, it is hovering close to the lower end of the band, at 0.07 per cent.
“The longer we sit down here at zero the more distortions you are going to see,” warned Scott Skyrm, a repo trader at Curvature Securities.
The Fed has already raised the amount of cash that banks and money market funds can park at the central bank through its so-called overnight reverse repo, or repurchase agreement, facility. This means they do not have to invest in short-term debt, driving rates down. Usage of the facility has been elevated.
Minutes from the March FOMC meeting and recent comments from Lorie Logan, a top official at the New York Fed, suggest other changes may be afoot should “undue downward pressure on overnight rates emerge”. One option is for the Fed to adjust the interest it pays banks on reserves they hold at the central bank.