COVID | Monetary Policy & Inflation | US
September 2020 FOMC Preview: Struggling To Enhance Their Extreme Dovish Stance
- By Dominique Dwor-Frecaut and George Goncalves
- 3 min read
Economic uncertainty and recent signs of a slowing recovery suggest the Fed will maintain its cautious outlook and the 2021-22 Summary of Economic Projections (SEP). The Fed will look for ways to enhance its extreme dovish bias without spending much actual policy ammunition. Chair Powell will likely use the press conference and the SEP to do so.
Fed Economic Outlook Likely Unchanged
We expect the 2021-22 SEP to remain broadly unchanged, though the 2020 forecast will get updated to reflect stronger unemployment and inflation than in the June SEP. In addition, the second paragraph of the FOMC statement is likely to include some mention of the recent signs of recovery slowdown. Finally, the Fed could lower the LR dot to signal its commitment to extreme dovishness. We base our view on the Fed risk management strategy, their economic narrative and on recent data.
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Economic uncertainty and recent signs of a slowing recovery suggest the Fed will maintain its cautious outlook and the 2021-22 Summary of Economic Projections (SEP). The Fed will look for ways to enhance its extreme dovish bias without spending much actual policy ammunition. Chair Powell will likely use the press conference and the SEP to do so.
Fed Economic Outlook Likely Unchanged
We expect the 2021-22 SEP to remain broadly unchanged, though the 2020 forecast will get updated to reflect stronger unemployment and inflation than in the June SEP. In addition, the second paragraph of the FOMC statement is likely to include some mention of the recent signs of recovery slowdown. Finally, the Fed could lower the LR dot to signal its commitment to extreme dovishness. We base our view on the Fed risk management strategy, their economic narrative and on recent data.
Since the GFC, the Fed has based their risk management strategy on the principle that it is easier to tighten policy than to loosen it. Powell has continued to implement this strategy, as shown by his statement at the 29 July press conference that ‘our job is not to plan for the upside case. The upside case – we’ve got that covered. We’ve got to hope for the best and plan for the worst.’
The core Fed COVID-19 narrative is that we are moving through a three-step recovery, as Powell explained at the July meeting:
- Phase 1: lockdown.
- Phase 2: re-opening, where those working in activities ‘without exposure to lots of people in tight groups’ can return to work.
- Phase 3: protracted recovery, where unemployment remains high for a ‘couple of years’ because ‘The part of the economy which involves getting people together, and feeding them – flying them around the country, having them sleep in hotels and entertaining them – that part of the economy will find it very difficult to recover. That is a lot of workers.’
Finally, recent data suggests the recovery is stalling. The pace of NFP growth has slowed since June and initial unemployment claims are starting to rise. In addition, new COVID relief from Congress, which Powell diplomatically called for at the July press conference, is looking less and less likely.
Therefore, despite the sharp fall in new COVID cases, the 2021-22 SEP is unlikely to change much. This will be both as a result of the economic outlook and to reaffirm the July message that the Fed is still not even considering raising rates.
The one close-call area is the long-run dot forecast. Currently, the only points on the curve that get anywhere near the Fed’s 2.5% long-run interest rate estimate are the 30yr Treasury and deep forward rates in the future. If we compare the 2.5% estimate vs forward inflation expectations, that puts real Fed funds at a high 0.75%. The risk is that if the Fed wants to out-dove markets, they could lower the long-run dot at this meeting.
Meeting to Focus on Further Socialization of Average Inflation Targeting
The Fed dislikes surprising markets, and recent FOMC members’ speeches and Q&As – as well as Nick Timiraos’ well-informed WSJ articles – suggest no additional changes to the framework this time around. Rather, the meeting will probably focus on further explaining the move to average inflation targeting (AIT).
The Fed could accomplish this explanation through the meeting statement and the 2023 SEP. The meeting statement will likely be amended to reflect recent changes to the Statement on Longer Run Goals and Policy Strategy. For instance, the references to ‘maximum employment objective’ and ‘symmetric 2% inflation objective’ could become ‘broad-based and inclusive maximum employment objective’ and ‘inflation that averages 2% over time’, respectively.
In addition, this time around the SEP will include the first 2023 forecast, which could be an opportunity for the FOMC to demonstrate how AIT could work. For instance, 2023 unemployment could be somewhat below and inflation somewhat above the longer-run forecast with the Fed Funds still at 10 bp. In any event, Powell will likely be asked at the press conference how AIT has influenced the SEP.
Fed on Hold
Overall, the Fed is likely to remain in a holding pattern until post-election, which is the next time the FOMC meets. Now, granted, if the recent volatility in stocks were to flare up again and result in a major market meltdown, we are sure the Fed would pull out all the stops and try to jawbone stocks by stating they could do more. However, the situation would need to significantly deteriorate to see the Fed come out with an intra-meeting ease between this meeting and the November election.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
George is a twenty years fixed income veteran. Over that time he has been an active participant on the research and investment side covering rates, structured products and credit. He worked both on the buy-side and sell-side. He can be reached here.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)