MNI POLICY: Fed: Virus is Major Medium-Term Risk, Holds Rate

The Federal Reserve on Wednesday left interest rates around zero and made no changes to its historic balance-sheet policies in a widely expected pause, while further shifting concern from a near-term shutdown to a much longer economic downturn.

[see a comparison of the July versus June statement here: FOMC July Statement Comparison.pdf]

The central bank is "is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals," the Fed said in its post-meeting statement.

Economic activity and employment "picked up somewhat in recent months but remain well below their levels at the beginning of the year," the Fed unanimous decision said.

Policymakers had initially hoped for a rapid, "v-shaped" recovery from the coronavirus downturn, but the reality has been a lot more grim. Gross domestic product is set to drop of over 30% on an annualized basis for the second quarter, by far the worst showing since data collection began.

"The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term," the Fed said. Policy makers will hold rates "until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals."

UNEMPLOYMENT

The official jobless rate, which had been at historic lows around 3.5% at the start of this year, has spiked into double digits. It stood at 11.1% last month but volatility means that may not be the recession peak.

Inflation, which already failed to hit the Fed's 2% target for much of the last economic recovery, is now veering even further away from that goal. The Fed cited "weaker demand and significantly lower oil prices" for slowing price gains.

The Fed reacted swiftly once the pandemic's broader economic implications became clearer in March, in part because key financial markets including Treasuries suddenly froze up.

Not only did the Fed again yank official borrowing costs down to zero, following a similar course during the Great Recession of 2007-2009. It also revived many emergency credit facilities and concocted several new ones as well, in an effort to ensure that the public health crisis did not turn into a financial panic.

Many of these programs have seen weak demand, but many officials expect take-up to rise as forbearance schemes that dominated the immediate post-shutdown environment expire.

Later this year, the Fed is expected to unveil a new policy framework, which is likely to move toward an average inflation target that emphasizes the central bank's desire to consistently hit its 2% goal.

Officials are also working on forward guidance about the preconditions for an eventual monetary tightening that for now remains nowhere near the horizon.