The Fed Open Market Committee (FOMC) concluded its latest policy meeting yesterday and to the surprise of no one voted to keep its key interest rate near zero (0.00-0.25%) indefinitely. The Fed also pledged to continue its aggressive purchases of Treasury securities, mortgage-backed securities and other assets (more on this below).
The FOMC also released its latest forecasts for the economy. The Fed expects US GDP to fall by 6.5% (annual rate) in 2020, down from its previous estimate of +1.2%. The Fed projects a rebound to +5.0% in 2021 and +3.5% in 2022.
The Fed estimates the unemployment rate will average 9.3% in 2020 followed by 6.5% in 2021 and 5.5% in 2022. The Fed’s favorite indicator of inflation (core Personal Consumption Expenditures) shows prices increasing by only 1.0% in 2020 followed by 1.5% in 2021 and 1.7% in 2022. The Fed seemed to be acknowledging that core inflation will remain below its target of 2% indefinitely.
Since March, the Fed has held its benchmark short-term interest rate, the Fed Funds rate, near zero and now expects that rate to remain “zero bound” for at least a couple more years. During that same period, the Fed has aggressively purchased nearly $2.5 trillion in Treasury and mortgage bonds and other assets including certain ETFs.
This unprecedented bond buying spree has been an attempt to keep the financial markets liquid and free-flowing to support the economy. Most forecasters believe the downturn in the economy would have been even worse were it not for the Fed’s record large asset purchases, which it pledged to continue yesterday.
Given these massive asset purchases in recent months, the Fed’s balance sheet has exploded to above $7 trillion as you can see below. Nothing remotely this massive has ever happened before, including during the Great Recession of late 2007-early 2009. If the Fed makes good on its latest pledge to maintain, or even increase, asset purchases going forward, it is highly likely the Fed’s balance sheet will top $10 trillion by the end of this year.
No one knows whether there is any limit to how much the Fed can balloon its balance sheet. Clearly, we are in uncharted territory!
Worrisome as it may be, the Fed’s actions are widely credited with having helped fuel the extraordinary rally in the stock market, which has recovered to near its pre-pandemic high after a dizzying plunge in March. And by committing to buy corporate bonds, reinvigorating the market for such securities, the Fed has also ensured that corporations can continue to borrow.
The Fed’s initiatives in recent months also include a first-ever program through which the Fed is buying state and local government debt to support the municipal bond market. In early April, the Fed unveiled several new lending facilities available to states, localities and corporations and authorized up to $2.3 trillion in lending to these entities. This is also unprecedented.
Most economists say those steps have prevented the downturn from getting even worse, by keeping credit flowing.
On Monday of this week, the National Bureau of Economic Research (NBER), the official arbiter of when recessions begin and end, declared that the US economy entered a recession in February as the coronavirus struck the nation.
Normally, the NBER defines a recession as two consecutive quarters of negative economic growth. But in this case, the NBER said the collapse in employment and incomes was so steep that it could much more quickly make a determination. The NBER explained:
“The unprecedented magnitude of the decline in employment and production, and its broad reach across the entire economy, warrants the designation of this episode as a recession, even if it turns out to be briefer than earlier contractions.”
I completely agree and I don’t believe we’ve seen the worst of this recession yet. While we’ve seen a rash of business bankruptcies already this year – including JC Penny, Pier 1, J. Crew, Tuesday Morning, Neiman Marcus, just to name a few – it is becoming increasingly clear that a much larger wave is coming. And this wave may include many businesses and institutions you might not expect. Think airlines, colleges, churches, non-profits, etc.
I’ll have more on this topic next week in Forecasts & Trends. If you are one of my few Blog subscribers who don’t also receive Forecasts & Trends, you can sign up here to receive it free each Tuesday.
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