FED OFFICIALS IDENTIFIED U.S. OUTLOOK AS "PROFOUNDLY UNCERTAIN" / THE FINANCIAL TIMES

Fed officials identified US outlook as ‘profoundly uncertain’

Policymakers unleashed a vast array of tools to limit economic damage as coronavirus spreads

James Politi in Washington and Colby Smith in New York


Officials at the Fed are grappling with little clarity on when economic conditions might improve © REUTERS


Federal Reserve officials feared a sharp decline in economic and market conditions last month as they began injecting a heavy dose of monetary stimulus to limit the fallout from the coronavirus pandemic.

According to minutes of emergency meetings of the Federal Open Market Committee in March, US central bankers “viewed the near term US economic outlook as having deteriorated sharply in recent weeks and as having become profoundly uncertain”.

Officials at the Fed were also grappling with little clarity on when economic conditions might improve.

“The timing of the resumption of growth in the US economy depended on the containment measures put in place, as well as the success of those measures, and on the responses of other policies, including fiscal policy,” Fed officials said, according to the minutes.

The minutes released on Wednesday came from two emergency meetings of the FOMC held on March 3 and 15, during which the US central bank took action to shield the US economy from the fallout of the coronavirus pandemic.

The Fed lowered interest rates close to zero, launched a sharp expansion of its balance sheet by buying up US Treasury debt and mortgage-backed securities, and set up swap lines with other big central banks.

Since March 15, it has gone even further, ramping up its crisis response well beyond its scope in the 2008 financial crisis, including the announcement of a series of facilities aimed at shoring up the markets for commercial paper, municipal debt and corporate bonds. The central bank also authorised itself to buy an unlimited quantity of US Treasuries and agency mortgage-backed securities.

Participants prominently cited the possibility of the virus outbreak becoming more widespread than expected. Such an event could lead to more wide-ranging temporary shutdowns, with adverse implications for the production of goods and services and for aggregate demand.

The Fed’s actions reflected a brutal change of outlook compared with earlier in 2020. In late January, the FOMC had gathered amid expectations of steady growth in the US economy, holding its main interest rate in a range of 1.5 per cent to 1.75 per cent.

Despite the disease’s appearance and proliferation in the city of Wuhan, China, in previous weeks, it was only just starting to register as a threat to the global economic picture. Fed officials had agreed that it “warranted close watching” at the time, according to the minutes from the late-January meeting.

Just a month and a half later, market turmoil had become vivid worry at the US central bank, including conditions of “high volatility and illiquidity” in markets for US Treasuries and government-supported mortgage-backed securities.

“Participants expressed concern about the disruptions to the functioning of these markets, especially in view of their status as cornerstones for the operation of the US and global financial systems and for the transmission of monetary policy”, the minutes said.

Treasuries sold off following the release of the minutes, with the yield on the benchmark 10-year note rising roughly 0.06 percentage points to 0.77 per cent. The more policy-sensitive two-year note yield edged higher to 0.26 per cent. Yields rise when prices fall. The S&P 500 extended earlier gains, rising more than 3 per cent.

Investors have welcomed the Fed’s wide-ranging steps, noting the actions have helped immensely to address strains that emerged across financial markets.

“The Fed has done a phenomenal job in terms of being as transparent as possible and as open as possible to continue down the path of providing support,” said Nick Maroutsos, co-head of global bonds at Janus Henderson. “They are providing a backstop and helping those who need it, but ultimately they are leaving the door open for more stimulus.”

Still, some warn there are limits to what policymakers can do.

“There will be some collateral damage,” said Padhraic Garvey, regional head of research at ING, pointing specifically to the corporate sector, which has been hard hit by government-mandated closures and orders for citizens to stay home.

“There is residual credit risk out there that I’m fearful of, and I do feel like the next phase of this is trying to assess what the default rate will be for the corporate sector,” he said. “You have to assume a default rate that is probably double digits.”

Jay Powell, the Fed chairman, is expected to deliver remarks on Thursday morning, which could offer further clues to the US central bank’s thinking. The next FOMC meeting is set for the end of April.

During the March meetings, officials fretted that their heavy-handed action might be interpreted as an overly pessimistic signal for the economy, or entrench expectations of negative interest rates, which the Fed has so far resisted. But Fed officials stressed they still had room for additional policy action with interest rates close to zero.

“In particular, new forward guidance or balance sheet measures could be introduced,” the minutes said.

Most recently, the Fed eased a capital rule for large banks to encourage lending and unveiled a new facility to allow central banks and other international entities to swap their Treasury holdings for dollars. The move is aimed at easing a global shortage of the US currency that had already prompted it to lower the cost of borrowing dollars globally through existing swap lines.

Since the outbreak of the coronavirus in the US, the Fed has been pushing banks to offer more credit to the economy, on the grounds that they are in a much better position than during the 2008 financial crisis and can play a key role in propping up many companies. But according to the minutes, some Fed officials said the banks should be “discouraged from repurchasing shares from, or paying dividends to, their equity holders”.

It was the debate around how the crisis might unfold that was among the most heated.

Some Fed officials stressed that the shock would be temporary in nature, the financial system was solid compared with a decade ago, and central bank action would offer strong support. Yet on the other hand some US central bankers were concerned that the situation might even be worse than assumed.

“Participants prominently cited the possibility of the virus outbreak becoming more widespread than expected. Such an event could lead to more wide-ranging temporary shutdowns, with adverse implications for the production of goods and services and for aggregate demand,” the minutes said.