The substantial buildup in anticipation of this week’s Federal Open Market Committee (“FOMC”) two-day meeting and accompanying statement, along with Federal Reserve Chairman Jerome Powell’s press conference and Q&A session, failed to provide the level of policy clarity that was highly anticipated by the markets. This, along with positive retail sales and jobless claim numbers, neglected to move the interest rate markets much this week as Treasury and interest rate swap yields once again traded within narrow ranges of two to three basis points (0.02% – 0.03%) for shorter maturities to seven basis points (0.07%) on the very long-end of the yield curve.
Rates ended Wednesday little changed after rising following the release of the FOMC’s statement on monetary policy and comments by Fed Chair Powell.
Yields initially edged higher after the FOMC statement release and reached session highs during Powell’s comments on Fed asset purchases. The ten-year Treasury yield rose 2.1 basis points (0.021%) to 0.70%, its highest level during week, before closing just below this mark.
For the foreseeable future, the Fed will maintain its current pace of asset purchases. Fed asset purchases are currently $80 billion per month of Treasuries and $40 billion per month of Mortgage-Backed Securities (“MBS”). Powell said the Fed will adjust the program as appropriate, without suggesting any increase in purchase sizes or any shift in the composition of purchases toward longer-dated bonds.
The central bank’s new outcome-based guidance on the path of interest rates was light on specifics. Fed officials determined several months ago that providing greater clarity to the market regarding the likely future path of rates “would be appropriate at some point.”
That point came this week as the FOMC debuted its so-called “enhanced forward guidance,” which more explicitly ties future interest rate increases to somewhat vague economic outcomes. In its official statement, the central bank pledged to keep the fed funds rate unchanged in a range of 0% to 0.25% “until labor market conditions have reached levels consistent with the committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.”
Phrasings such as “maximum employment” and “on track to moderately exceed 2% for some time” are unclear, continuing the market’s uneasiness with the future path of interest rate yields, both in the short and the long-term. Fed officials can have different opinions on whether inflation is “on track” to exceed 2%. They can have different interpretations of “moderately exceed” as well – is it 2.25%, 2.50%, 3.00%, or more? Lastly, officials can have different assessments of “some time” – does this imply an inflation averaging period of six months, a year, two years, or longer?
Nevertheless, Powell considered this to be “strong policy guidance” for the markets, stating that the Fed is “resisting the urge to try to create some sort of a rule or a formula here”.
Removing the ambiguity from the Fed’s statement would have reassured the markets but the Fed needs maximum flexibility to deal with recent extraordinary economic events. The Fed is set to remain abundantly accommodative to help correct the current economic crisis and inflation will likely have to increase beyond their undefined comfort zone before this stance changes in any significant fashion.
In his press conference and Q&A session following the FOMC release, Powell noted that economic activity has picked up since the second quarter lockdown. But the recovery has not been equal across all sectors. Spending on person-to-person services remains very weak. Powell emphasized that the pandemic is still the key factor for the economy. He further commented that consumer confidence needs to recover further and reiterated again that additional fiscal policy to help support the economy would also be quite welcome. The Fed cannot fight the current economic crisis alone.
FOMC adjusts its projections for GDP and unemployment
In addition to its enhanced forward guidance, the FOMC altered its outlook for GDP and unemployment, among other economic indicators, for the coming years.
The committee now sees a full-year 2020 GDP decline of 3.7%, considerably better than the 6.5% drop forecasted in June. However, it lowered its 2021 GDP median growth outlook to 4% from 5%, and 2022 GDP to 3% from 3.5%. The committee expects GDP growth to continue to decelerate in 2023, to only 2.5%.
From its historical 14.7% peak at end of April, to its current level of 8.4%, the Fed anticipates unemployment to fall further to 7.6% by year-end 2020. The Fed forecasts unemployment to continue to decline to 5.5% in 2021, 4.6% in 2022, and 4.0% in 2023. There were no comments on whether or not an unemployment rate of 4.0% would constitute “maximum employment”, as discussed previously.
Americans continued to spend in August, but at slower than forecasted levels
Retail sales climbed 0.6% in August, the Commerce Department reported on Wednesday. But the increase was smaller than in previous months, prompting concerns of a recovery that is slowing down.
Despite an end to the federal stimulus measures that have propped up consumer spending, retail sales climbed for the fourth straight month in August, extending a rebound that has lasted longer than many expected.
The large gains achieved by reopening a shuttered economy are behind us, and the downside risk of slower growth is emerging. The 1.2% increase in July was revised down to a 0.9% gain. Recent gains have been smaller than in previous months, which some economists warn could be a sign that the retail recovery is running out of steam.
Further gains will be harder to achieve given the lack of new fiscal stimulus along with high levels of unemployment which will slow the American propensity to spend going into the holiday season. The slower rise in consumer spending in August occurred as the $600/week supplemental unemployment assistance expired and Congress failed to agree on any new stimulus measures. The slight August sales increase, below an estimated increase of 1.0%, showed just how vital government assistance has been. Unemployment has declined, but it is still extremely high as large sectors of the economy, like hospitality, food services, and travel, remain largely shut down.
The latest retail sales data is likely to add to the calls for Congress to pass another round of stimulus before the November elections.
The bottom line is that American consumer spending on goods has been bouncing back from its steep pandemic drop, while spending on services remain impaired.
Initial jobless claims unexpectedly fall for the week
First-time claims for state unemployment insurance beat estimates, with filings totaling 860,000 for the week ended September 12th, the Labor Department reported Thursday. Economists expected 875,000 new claims, against the previous week’s upwardly revised claims of 893,000.
Last week’s results represent a downward trend from the peak of 6.9 million claims in late March as the economy shut down. Since then, the labor market has recovered, though millions remain unemployed.
Initial claims had remained above 1 million per week through late August. In September, the Labor Department changed the way it adjusted for seasonal factors to account for the influence the virus measures have had on the economy, also contributing to the lower numbers.
Another piece of positive employment-related news was a decline in continuing jobless claims. After peaking at 24.9 million in early May, these claims fell by 916,000 to a weekly level of 12.63 million, below the consensus forecast that called for over 13 million workers to still be on the unemployment insurance rolls.
The pace of jobless claims is continuing to fall, while the total is still considerably above anything the U.S. has likely ever seen and is certainly still near its highest levels since this report began in 1967.
Housing continues to provide a boost to the economy
The National Association of Home Builders (“NAHB”) Market Index continued its surge since its low point of 30 in April, rising to an index level of 83 for September. Readings that drop below 50 indicate weakening sentiment while readings rising above 50 indicate an improving view of positive conditions.
Although new housing starts fell 5.1% overall in August due to a slump in multifamily construction, single-family starts, a far larger part of the housing market, jumped by 4.1%. New permits fell 0.9% overall, but those for single-family homes rose 6% against a slump of 14.2% in multifamily permits.