As the Federal Open Market Committee gathers this week for its first meeting of 2021 — and the first since Joe Biden became president — the US central bank faces a stalling economic recovery hampered by a high level of coronavirus cases.
But the new year has also brought fresh prospects of additional fiscal aid — for which chairman Jay Powell has advocated strongly to offset the economic damage inflicted by the pandemic.
Here are five things to watch as the Fed meets:
Since Fed officials convened in December for their final meeting of 2020, evidence has piled up that the economic recovery has lost steam. New claims for US unemployment benefits remain alarmingly elevated and retail sales have slumped.
While the outlook over the next few months has darkened, the prospects of a stronger rebound in the second half of the year are brighter, leaving the Fed in a holding pattern when it comes to policy.
Wednesday’s FOMC statement is unlikely to contain big changes with regards to economic conditions, but Mr Powell may offer some better indication of the short-term outlook, and whether his confidence in an improvement later this year still holds — particularly in light of concerns about the pace of vaccination rollouts.
The fiscal picture has improved since December, with the enactment of an initial $900bn stimulus deal. But Mr Biden is trying to do more, starting with a relief plan worth $1.9tn. Even if it is watered down by Republicans to $1tn, as strategists at Natixis have predicted, it would still be a big boost.
The meeting will be the first since Mr Biden moved into the White House, and Mr Powell may have to clarify his stance on the new administration’s top legislative priority.
Mr Powell had made no secret of his support for the last fiscal deal in order to create a bridge through the winter into more favourable conditions for a recovery. But does he still believe that additional fiscal support is necessary, or does he agree with many Republicans that the Biden administration’s proposal could be excessive? And if Mr Powell does support further action, what areas should be the priority?
Investors are on high alert for signals the Fed may consider scaling back its support for financial markets as early as this year, given a robust economic rebound is expected to soon gather speed.
A handful of regional central bank presidents jolted rates markets earlier this month by speculating that the Fed could begin winding down its massive $120bn-per-month asset purchase programme by the end of 2021. Senior Fed officials, including Mr Powell and vice-chairman Richard Clarida, aggressively pushed back on the timeline, underscoring the severity of the contraction caused by the pandemic and the risk of withdrawing from markets prematurely.
Mr Powell is expected to affirm the Fed’s commitment to keeping its monetary policy extremely easy for the foreseeable future on Wednesday, but investors warn that the central bank may soon have to think about its exit strategy.
Economists have revised higher their growth forecasts for the year, in light of the Biden administration’s $1.9tn stimulus plan. Market measures of inflation expectations have also soared, with the 10-year break-even rate derived from US inflation-protected securities climbing well above 2 per cent.
“We are fairly optimistic that by the time we get into the summer and fall of this year, we are going to be in a much different economic environment than we are today,” said Ken Taubes, chief investment officer for the US at Amundi. “The heat in the kitchen is going to get pretty hot for the Fed.”
A new set of voting members at the FOMC — who will weigh in on the central bank’s monetary policy stance — will be installed this week.
The annual rotation brings in Atlanta Fed president Raphael Bostic, Charles Evans from Chicago, Mary Daly from San Francisco and Richmond’s Thomas Barkin. They will replace Fed regional bank heads from Philadelphia, Cleveland, Dallas and Minneapolis.
The four new voters give the committee “a marginally more dovish make-up”, according to Kathy Bostjancic, chief US financial economist at Oxford Economics. This makes it unlikely that the Fed will deviate sharply from its ultra-accommodative approach to weathering the coronavirus crisis.
Ms Bostjancic expects the Fed to tilt even more dovish once Mr Biden nominates someone to fill the last seat on the board of governors. The position was left open after the US Senate blocked confirmation of Judy Shelton, a fierce critic of the central bank.
Mr Powell may also field questions about new leadership at the Treasury department, after the US Senate confirmed former Fed chair Janet Yellen to take the helm of the top agency responsible for managing the US economy.
Ms Yellen takes the reins on the heels of a dust-up late last year between Treasury and the Fed over the fate of multiple lending programmes aimed at helping small businesses, larger corporations and state and local governments manage the coronavirus-induced financial panic. Steven Mnuchin, Treasury secretary at the time, refused to extend the facilities beyond their December 31 expiration date, against the wishes of the central bank.
The urgency to reinstate these programmes has ebbed somewhat as markets have bounded to fresh all-time highs. But should volatility return, “Biden’s Treasury will be more amenable to working with the Fed”, added Ms Bostjancic.