The Federal Reserve spent last March unlike any other, axing interest rates to zero at the fastest pace in history and unfurling an unprecedented suite of emergency loans — remarkable moves that symbolized just how crushing the coronavirus pandemic would be for the job market and financial system.
One year later, however, and the U.S. economy looks like it’s on track to chart a dramatic reversal, thanks to three vaccines and a second near-$2 trillion stimulus package. The brightest of estimates pencil in a rapid rebound that could be twice as fast as expected.
But as the Federal Open Market Committee (FOMC) gathers for its March 16-17 policy meeting, officials’ main job will be convincing consumers and markets that the work isn’t over and that the tune won’t change, even as the times do. Fed Chairman Jerome Powell is likely to reiterate in a post-meeting press conference that the bar will still be high for raising interest rates from their rock-bottom levels, to give the economy ample time to run even as some corners of the market fret over rising inflation.
Here’s three main themes that are going to be important for officials (and Fed watchers keeping close tabs on them) as they seek to not only steer the economy past the crisis, but back to the buzzing labor market backdrop that prevailed before the pandemic began.
1. Pay close attention to the Fed’s updated economic projections, then (maybe) throw them out
The Fed’s meeting is expected to be absent of major rate or policy changes, but the most important news will be where officials see the economy — and rates — heading over the next few years.
For the first time since December, the Fed will be updating its Summary of Economic Projections, which contains forecasts for unemployment, inflation and gross domestic product (GDP). A lot of important economic news has happened since then.
That includes President Joe Biden taking office and passing the massive $1.9 trillion American Rescue Plan at the top of his list. Also up there is the $900 billion supplemental coronavirus relief bill. The Fed’s forecasts will illustrate just how much those two bills might shift the outlook.
If private sector commentary is any indication, the impact will be substantial. Morgan Stanley equity strategist Michael Wilson wrote in an early March note to clients that the “recession is effectively over” thanks to the bill’s passage, while a Goldman Sachs report foreshadowed a hiring boom that cut push unemployment down to 4.1 percent.
It wouldn’t be surprising if Fed officials echoed that confidence, upgrading their GDP estimates and lowering their unemployment rate forecasts.
Fed’s dot plot: Will more officials expect a rate hike?
The Fed’s median rate forecast indicates that it isn’t expecting a rate hike through at least 2023. But if four more officials join the five officials who were previously penciling in an increase two years from now, that would shift the median up and essentially become the Fed’s first official forecast of how soon markets could expect them to lift rates.
Market participants won’t, of course, know which dot belongs to whom. But it would still be a remarkable shift, and perhaps more than anything, a powerful display of growing confidence.
A December survey from Bankrate showed that experts are expecting the Fed to hold rates at zero until 2024.
Remember: The Fed doesn’t have a crystal ball
But take those words with a grain of salt. For one, the U.S. economy is in uncharted territory, and the rebound could play out a lot differently than officials expect. Those forecasts show only what the Fed knows right now.
Meanwhile, Powell has underscored relentlessly that the U.S. economy is currently “a long way away” from requiring a rate hike. A new U.S. central bank mandate is also leading officials to prioritize lowering unemployment over curbing inflation.
“It will take some time to get back to maximum employment,” Powell said in a March 4 question-and-answer at a Wall Street Journal symposium. “It took us many years to get there before. And that’ll really just depend on how strongly the economy picks up once we do get past the pandemic and once economic activity picks up and hiring picks up.”
“Just because the economy is going to grow faster than initially expected this year, that doesn’t change that this economic rebound is being driven by stimulus,” says Greg McBride, CFA, Bankrate chief financial analyst. “The Fed has to look beyond just the short-term stimulus influence timeframe to what the economy is going to look like on the other side of that.”
Inflation picture: Will the markets and the Fed be off base?
Up in the air, however, is whether the Fed might also upgrade their inflation forecasts — and whether it might lead to jittery investors.
Markets are betting that a faster rate of growth and vaccinations, coupled with massive government spending and rock-bottom interest rates, might be the perfect ingredients. The 10-year Treasury yield has been steadily rising since the start of 2021. The rate, which is a benchmark for other types of consumer borrowing (such as the 30-year fixed-rate mortgage) ended February on a high note that many didn’t want to hit: 1.41 percent.
The Fed is saying: Not so fast. To be sure, Powell has been very clear that he does expect prices to rise on some level, but he expects that those increases are likely to be more temporary than sustained.
“If we do see what we believe is likely a transitory increase in inflation where longer-term inflation expectations are broadly stable at levels consistent with our framework and goals, I expect that we will be patient,” Powell said.
2. The Fed might not be ready to provide investors with more clues on how they’re going to calm Treasury yield volatility
Treasury yields kicked off March on the same roller coaster as February. Investors will naturally be looking for more clarity on whether the Fed might be willing to adjust its bond-buying plans or roll out new emergency steps to keep rates low. Investors already know that the rate moves caught Powell’s attention, but he said the Fed would be more worried about a persistent tightening in financial conditions rather than an interest rate or price move on one asset.
The Treasury yield pick up is partially happening for good economic reasons. Before the pandemic ripped through the labor market, the 10-year yield hovered around 1.8 percent. Strong economic data might only permit some normalization of rates, which are still very low by historical standards (Back in 2018, for instance, the 10-year yield kicked off at 2.46 percent).
“Powell has apparently disappointed markets by not voicing a willingness to jump into the fray right away,” McBride says. “The Fed is just going to emphasize that the run-up in yields is consistent with a better outlook for the economy and the prospect for higher inflation, but they’ll continue to be laser-focused on the fact that we have a labor market that is a long way from its pre-pandemic level.”
If officials want the economy to run hot, they might not want to let rates rise too much further, though the threshold at which they’d be uncomfortable is anyone’s best guess. Experts say that’s most likely somewhere around 2 percent.
In those circumstances, the Fed could choose to shift its asset purchases to more longer-dated bonds, which would have more of a stimulative effect on the economy. A more unconventional tool known as “yield curve control” could also be on the agenda, though experts say that’s less likely at this point.
The Fed might also want to preserve the remaining ammunition it has left to stimulate the economy when it’s truly desperate, not to calm investors’ tantrums who, some experts say, might be addicted to being rescued.
“We’ve been conditioned to believe ‘mom and dad’ will bail us out,” says Dominic Nolan, CFA, senior managing director at Pacific Asset Management, referring to the Fed. “2008 is where it started, and in multiple situations since. It wasn’t Bank of America rescuing liquidity, but the Fed.”
3. In the Fed’s eyes, monetary policy is going to be all about looking underneath the economy’s hood
Even if officials do strike a more confident tune, the main message will be that it isn’t time for the Fed to bow out of the game.
Illustrating perhaps just how hot an economy Powell and Co. might be looking for, the chief central banker in his most pointed remarks yet suggested in a March 4 speech that the Fed won’t be relying on headline numbers when assessing just how strong the economy and labor market is.
“Four percent would be a nice unemployment rate to get to, but it will take more than that to get to maximum employment,” Powell said, adding that officials have a “high standard” for what constitutes full employment. He said officials will also pay close attention to labor force participation rates, the ratio of how many of the working-age labor force is currently employed and then wage growth.
During a semiannual congressional testimony to Congress in February, Powell also preached to lawmakers that actual joblessness was likely twice as high as the headline number, when you take into account just how many have stopped looking for work because of the recession.
Another troubling sign: Rising long-term unemployment. Individuals who’ve been without a job for 27 weeks or more now make up 41.5 percent of the total unemployed, and history suggests that those figures will only keep rising as the labor market remains weak while it climbs out of the pandemic.
“The labor market is a flat tire, and the little warning light on our dashboard keeps flashing. We need to put air in the tires,” says William Spriggs, chief economist at the American Federation of Labor and Congress of Industrial Organizations. “We’re supposed to run the economy at full potential, because every time you don’t reach full potential, it compounds. You compound a smaller economy moving forward.”
What this means for you
Homeowners and those considering refinancing might be fretting the recent pick up in yields, but you haven’t entirely missed your chance to refinance. You should, however, consider whether it’s time to jump on the train now, given the prospect of higher yields down the road with a brighter economic recovery.
Meanwhile, you still have time on your side to take advantage of historically low interest rates by paying off debt, particularly high-cost credit-card borrowing. Those interest rates aren’t as sensitive to short-term fluctuations and are based off of the Fed’s short-term benchmark, the federal funds rate.
Take advantage of key forbearance programs if you’re in rough financial shape. Biden extended a federal student loan forbearance and interest waiver program through September and a federal foreclosure moratorium through June.
When you get your stimulus check, consider using it to fund your emergency savings, pay bills or cover existing debts.
“It’s abundantly clear that short-term rates aren’t going up anytime soon,” McBride says. “Seeing faster economic growth, that’s proof that low rates are working. Business has to be there before people are going to hire. As the economy continues to grow and expand, that should improve the fortunes of the labor market. The risk of raising rates is that you curtail that labor market improvement too soon.”
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