In Powell’s upcoming speeches, we will be focusing on his comments related to negative rates. Since the April meeting, market pricing of the future fed funds rate has dipped into negative territory. However, Powell has firmly stated and then reiterated the unanimous stance of the Committee on this topic: “we do not see negative policy rates as likely to be an appropriate policy response here in the United States.”
While the recent movement in fed funds pricing may reflect technical factors, there is also a fundamental question about how the Fed will be able to provide sufficient accommodation to an economy that is experiencing an unprecedented shock to aggregate demand if yields are at record-low levels and negative interest rates are not an option. The Committee has refrained from addressing these more medium-term considerations, but we anticipate - and the market may demand - that they provide greater clarity about the Fed’s approach. We discuss our view on what the Fed is likely to do and how it will commit to this objective.
We doubt Powell will have much new to offer on the economic outlook. The decline in April nonfarm payrolls was slightly better than our projection, as was the unemployment rate. However, similar to last month, the U-3 unemployment rate was substantially understated, potentially by as much as five percentage points. If there was one silver lining in last month's employment figures that Powell may reference, it was that the vast majority of unemployed were "on temporary layoff" compared to the small minority who were "not on temporary layoff". These categories will be key to gauging the recovery.
Last week, we updated our economic outlook to reflect the disruptions that Covid-19 and the related containment measures have inflicted on the US economy, which we anticipate will result in a sharper near-term collapse in economic activity followed by a more gradual recovery in the second half of the year. Our research details our latest expectations on real GDP for the second quarter and the back half of the year – as well as for full years 2020 and 2021. While financial markets may continue to look past the litany of bad data, the real test will be when the data begin to clearly inflect and the shape of the recovery emerges.
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