The Federal Open Market Committee meets this week at an important juncture for the US economy. While the outlook for 2021 has improved due to the rollout of the coronavirus vaccine, the short-term picture has deteriorated since monetary policymakers last met due to the worsening pandemic.
This has created a dilemma for Jay Powell, the Fed chair, and other officials. They have consistently said they were prepared to provide the recovery with more monetary support, including by bolstering their asset purchases, if needed. But is now the moment?
As they meet for the last time in a tumultuous year, and for their final gathering before Joe Biden takes office as US president, here are four things to watch.
Since June, in the early months of the pandemic, the Fed has been buying $120bn of US government debt each month — $80bn across Treasuries of all maturities and $40bn of agency mortgage-backed securities — and has said it would maintain that policy “over the coming months”. On Wednesday, it is expected to make one big signalling change in that regard, extending the timeframe for those debt purchases by linking them to certain economic metrics in the recovery.
But there has been pressure from some investors and economists to do more. Against the backdrop of rising Treasury yields and a flood of new longer-dated debt issuance by the Treasury department, the Fed may shift the bulk of its bond-buying to longer maturities.
Should the Fed hold off on making this change, some fear that borrowing costs could begin to creep up for American companies at a time when the economic recovery has begun to falter. Others point to the fact that financial conditions remain extremely accommodative to argue that a shift is unnecessary.
A more extreme, but less likely, option would be for the Fed to increase the aggregate size of its asset purchases.
The last forecast from the Fed in September suggested the US economy would contract by 3.7 per cent in 2020, followed by a 4 per cent rebound next year and the unemployment rate dropping to 5.5 per cent by the end of 2021.
Officials publish new forecasts on Wednesday and good news on vaccines may well lead to a rosier overall economic assessment — even though the first quarter of next year will probably be more dire than expected because of the worsening pandemic, since a number of labour market indicators have weakened sharply recently.
If the Fed does see solid macroeconomic improvement next year, it may lead officials to predict earlier interest rate hikes than they did in September, when the median prediction was for no lift off until at least the end of 2023.
This could be tricky for Mr Powell to manage from a communications standpoint, since he has often maintained a very dovish stance, stressing the downside risks to the outlook, and does not want to create any perception that the Fed sees the end of the crisis and is preparing to tighten.
This week’s meeting will be the first since a rift emerged between the central bank and the Treasury department over the fate of emergency lending facilities announced this year.
Steven Mnuchin, the Treasury secretary, has asked the Fed to return unused funds from five such programmes that are set to expire at the end of the month, including two set up to purchase corporate debt, five facilities to support small and medium-sized businesses and one that lends to state and local governments.
Mr Powell has repeatedly signalled his preference to keep these facilities active, especially in light of the fact that coronavirus case counts are surging and governments are reimposing lockdown measures that are bound to chill economic activity.
Investors are holding out hope that these facilities will be reinstated early next year after Mr Mnuchin hands the reins as Treasury secretary to Janet Yellen, the former Fed chair, so any signals on this from Mr Powell will be closely watched.
Mr Powell is probably tired of haranguing lawmakers on Capitol Hill for more fiscal stimulus, especially since his efforts have been in vain so far. But this week’s meeting will be his best chance to make the case for why only government spending can plug the holes in the recovery that are growing by the day, including aid to small business, state and local governments and the unemployed.
Pressure from Mr Powell may help lawmakers close in on a package worth somewhere between $748bn and $908bn — the latest iteration of a bipartisan proposal on the Hill — but an additional question for the central bank chief is whether he thinks the economy will need far more in the new year, as Mr Biden is calling for.