MNI PREVIEW: Fed Set To Pause, Ease Later in Year

By Pedro Nicolaci da Costa

     WASHINGTON (MNI) - The Federal Reserve looks set to take a break next week

from the extraordinary recent steps it took to support the financial system and

the economy from the Covid-19 pandemic shock, including open-ended commitments

to buying bonds.

     The Fed's two-day gathering will, however, feature a robust debate over

future ways to support an economy where 42 million people have filed for

unemployment benefits in just a couple of months, and is likely to need all the

monetary help it can get for the foreseeable future, despite a surprise 2.5

million jobs added in May.

     That could include a more specific QE program to cap rates, forward

guidance and a shift to an inflation make-up strategy to bring price growth back

to the Fed's 2% target.

     Importantly, the central bank will release its first set of economic

forecasts since December, having interrupted the quarterly release due to

extreme uncertainty related to the pandemic in March.

     Investors will look to the Summary of Economic Projections for signs of how

bad the Fed expects this slump to get and for how long officials expect to keep

rates near zero. From a labor market standpoint, things are already worse than

the Great Recession with unemployment surging to 13.3% in a matter of weeks. In

the last downturn, the jobless rate peaked at 10%, and took over a year to get

there.

     Current and former officials have also told MNI the Fed is actively

considering implementing caps on shorter-dated Treasury note yields, although it

is likely to wait a few more months before making a decision either way.

     --ECONOMIC PAIN SPREADS

     Business activity has collapsed in most sectors, particularly those service

industries most exposed to the pandemic, including restaurants, hotels and event

spaces. But few areas have been totally unscathed as Americans retreated into

their homes for, in many cases, state- and locally-mandate lockdowns.

     The Fed is closely watching major banks on Wall Street for signs that such

financial pain for households and corporations could lead to the kind of credit

crunch that could induce a financial crisis, according to an MNI report last

week.

     One thorny issue for Fed Chairman Jerome Powell, who will face questions

from reporters, is how to address the striking disconnect between financial

markets that have rallied sharply in part because of central bank support, and a

nose-diving real economy.

     While stocks keep climbing, second quarter U.S. gross domestic product is

expected to crash by around 40%, according to prevailing estimates.

     -- EMERGENCY LENDING FACILITIES

     This month's meeting will likely feature extensive discussion about the

array of steps taken as officials assess their effectiveness, the possible need

for tweaks to existing facilities, and the possibility of eventually resorting

to yet more special lending vehicles.

     The Fed and others hope for a second half recovery that will hinge in part

on the willingness of Congress to deliver more fiscal stimulus to support

economic growth.

     Aid to states and municipalities appears high on the list of priorities as

the pandemic, coupled with nationwide protests over the deaths of two black

Americans at the hands of police, strain local and state government budgets.

     The Fed started the year expecting to leave benchmark rates on hold in a

1.25%-1.5% range. However, the pandemic and its hit to growth quickly forced it

to bring borrowing costs down to zero, and launch a string of emergency

facilities to support various corners of the credit markets.

     Some lending measures were revived from the last crisis, while entirely new

ones were created, including ones aimed at corporate credit, "Main Street" loans

to medium- and small-businesses, as well as municipal bond buying and lending.

The Fed has yet to launch the Main Street program. It has started buying a small

amount of corporate bond ETFs but has yet to purchase bonds of individual

companies.

     The Fed's balance sheet has ballooned 67% to a record USD7.165 trillion

compared to early March, though borrowers are making modest use of its emergency

lending facilities.

     The Fed's newest facility to become operational, the municipal liquidity

program, this week made its first loan, to the state of Illinois for USD1.2

billion.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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