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Intesa Sanpaolo : FOMC super-dovish

Intesa Sanpaolo : FOMC super-dovish: “The Federal Reserve is committed to using its full range of tools to support the US economy in this challenging time”

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Weekly Economic Monitor – Weekly Economic Monitor – 12 June 2020

Intesa Sanpaolo – Research Department

The week’s market movers

This is the main message sent by the June meeting, that outlines a difficult and extremely uncertain macroeconomic scenario, marred by “considerable downside risks”. Forward guidance on rates is unchanged, but the dot plot signals stable rates over the whole forecasting horizon, and asset purchases “at least at the current pace” in the “coming months”.

– The opening sentence of the statement sums up the message conveyed by the Fed, that guarantees its active presence in a still bleak economic picture, watering down the optimism sparked among many market participants by the turnaround of the labour market trend in May, and by indications of an incipient post-lockdown recovery. The Committee discussed changes to guidance on rates, that was ultimately left unchanged, with expectations in any case anchored by projections of stable rates until the end of 2022. For what concerns the pace of security purchases, a temporary path is laid out, with a floor at the current level, and no ceiling. Overall, the FOMC, through the statement and Powell’s press conference, has sent dovish indications, stressing the downside risks and uncertainty surrounding a macro outlook that is only modestly positive, and very fragile.

– Macroeconomic scenario exposed to considerable downside risk. The macro picture is summed up in two sentences: the virus, and the resulting containment measures put in place, have caused economic activity and employment to contract sharply, while weakening demand and lower oil prices are holding back inflation. The improvement of financial conditions is the result of the public support injected to respond to the effects of the pandemic. Macroeconomic forecasts display huge dispersion across variables (Table 1), especially from 2021 onwards. The median scenario is relatively pessimistic for 2020 (unemployment rate at the end of 2020 of 9.3%, GDP -6.5% y/y) and points to unemployment higher than the longer-term rate, and inflation below the 2% mark along the entire forecasting horizon. Therefore, macro conditions justify the stable path of interest rates. In the statement, the Fed forecasts “heavy” consequences on economic activity, employment, and inflation in the near term, with “considerable risks” to the medium-term scenario.

– Rates unchanged throughout 2022. The Committee left the fed funds rate at between 0 and 0.25%, without changing the qualitative guidance provided in the past few months, reasserting that rates will remain stable until the Committee is confident that the economy has overcome recent events and is on the course to achieve the maximum employment and price stability goals. In the dot plot (Fig. 1), the median forecast is stable, and until the end of 2021 consensus is unanimous to keep rates on the verge of zero. For 2022, forecast dispersion is very limited, with only 2 dots out of 17 above the current interval (one at 0.250.50%, the other at 1-1.25%). Concerning potential changes to forward guidance, including yield curve control, Powell said that for now the stable future path of rates is evident and shared by the market, indicating that it is not urgent to strengthen guidance. However, the Committee has discussed the matter and will make a decision in “upcoming meetings”. The minutes, that will be published in three weeks’ time, will probably provide indications on the timing and type of any changes.

– A floor set for the purchase path, but no ceiling. For what concerns asset purchases, the statement signals that Treasuries, MBS and CMBS will be purchased “at least at the current pace”, specifying a better defined path for purchases, for which a floor is now set, but remains without a ceiling, with the aim of fostering effective monetary policy transmission. With the latest decision, the Committee instructs the NY Fed to confirm purchases at current levels in the “coming months” (Treasuries: +80 billion per month, MBS: +40 billion per month), interrupting the tapering process under way since May.    Emergency lending programmes crucial to sustain the recovery. During the post-meeting press conference, Powell reminded of the importance of the Fed’s lending power to extend credit to a wide range of economic players, and reasserted that the programmes are geared (and adjusted) to provide loans to help overcome the damage reaped by the shutdown phase. However, Powell said once again that in such a difficult context as the present, it could become necessary to activate the spending power of fiscal policy again.

– Dovish message on monetary policy. The statement ends signalling that “the Committee will closely monitor developments and is prepared to adjust its plans as appropriate”. The first and last sentence of the statement show that the FOMC considers the emergency phase ongoing and does not feel the need to add specific conditions to signal its readiness to act proactively, in the face of the massive uncertainty surrounding the economic and epidemiologic scenario. According to Powell, in the next few months the outline of the economic outlook could become a little less uncertain and guide potential changes to better anchor expectations. For now, however, the bias is unmistakably dovish, albeit without new forward guidance. As Powell said, the Committee is “not even thinking about thinking about raising rates”.

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