Jay Powell, the Federal Reserve chair, has delivered a wake-up call to equity markets. His testimony, following the meeting of the Fed’s interest rate setting committee, was a bracing riposte to the idea that the coronavirus and its economic impact will be quickly resolved, and that US companies will be able to pick up from where they left off before the pandemic shut down large parts of the country. He delivered a justifiably dire prognosis for the American economy.
The central bank’s forecasts, published alongside the decision of the Federal Open Market Committee, predict a 6.5 per cent contraction in the US economy this year with the unemployment rate ending at 9.3 per cent. While jobless figures that pointed to a decrease in unemployment, released last week, were a welcome surprise, Mr Powell said he was still concerned about the long-term damage to the economy: “Many millions of people” would not quickly be able to return to work, he said.
This was matched by a dovish message on interest rates. Mr Powell indicated that the central bank will not increase rates until at least 2022. “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” he said.
It may be a case of once-bitten, twice shy for Mr Powell. The attempt to “normalise” lending rates early in his term as Fed chair was aborted after the global economy started to slow. On Wednesday he said that before the pandemic hit, the US had “the first tight labour market for a quarter century” and this was beginning to lead to wage growth for disadvantaged groups. “We had every expectation that this would continue, and then this comes”, he said, “and it’s heartbreaking”. He added that despite low pre-pandemic unemployment the Fed had been seeing “almost invisible moves on inflation” and joblessness could have gone even lower.
Mr Powell’s dovish message and the Fed’s forecasts appear to have rattled investors: equity markets fell on Thursday as Wall Street opened. The extraordinary package of asset purchases and interest rate cuts already launched to cope with the coronavirus crisis had previously helped drive equity markets higher. Earlier this week the S&P 500, the main US index, recovered all of its losses for the year.
Investors also appear more concerned about a second wave of infections. Several US states are seeing a sharp rise in diagnosed cases since they eased lockdown, including California, Florida, Georgia and Texas. However, Steven Mnuchin, the Treasury secretary, ruled out any new lockdown measures, saying, “We’ve learnt that if you shut down the economy, you’re going to create more damage.”
A possible second wave likewise presents a problem for the Federal Reserve. In his remarks on Wednesday, Mr Powell appeared to rule out any possibility of cutting interest rates below zero. That leaves the possibility of additional quantitative easing or yield curve control, where the central bank intervenes to keep long-term interest rates at a particular target, in addition to the short-term interest rates it controls directly.
The Fed’s warnings are correct, as is the decision to leave interest rates on hold and communicate that clearly to markets: exuberance was overdue a correction. However, if necessary, the Fed may need to find a way to do more, especially if coronavirus returns in earnest. In that event fiscal policy will also need to step up. The Fed has not been misled by the apparent fall in unemployment nor by the rise in markets. America can only hope its Congress is just as clear-eyed.
