The Federal Reserve meets this week for the first time since the inauguration of President Joe Biden, who has pledged a swift fiscal policy response by his administration to the Covid-19 pandemic crisis.
“Biden, and Janet Yellen at the Treasury, are very eager to dispense stimulus,” said Ryan Giannotto, director of research at GraniteShares. “In many ways, Yellen is an answer to Powell’s prayers.”
Although some metrics show improvement, the current economic picture is, at best, a mixed bag, with flagging job market gains, anemic retail sales and a pandemic that is still out of control in parts of the country.
“In the short term, we’re still facing a relatively difficult picture,” Giannotto said. “The implications for the future will be important for investors.”
At Fed Chair Jerome Powell’s Wednesday news conference, investors will want reassurance that the central bank will continue to hold interest rates at near-zero levels for quite some time, and they expect Powell to reaffirm the Fed’s open-ended commitment to extremely accommodative policies.
“I think he might make comments to the extent that inflation has started to show some signs of budging, but nowhere to the levels that would alarm,” said Anu Gagger, senior global investment analyst for Commonwealth Financial Network.
Biden and Congressional Democrats have prioritized passage of additional fiscal stimulus on top of the $900 billion in aid to individuals, unemployed workers and businesses the lame-duck Congress passed just before the new year. Proponents say a robust response now is badly needed to mitigate further — and perhaps irreversible — damage to the nation’s commercial activity.
“Suddenly, the explosion for fiscal stimulus seems to ameliorate those concerns in the short term,” Giannotto said. “It went literally from one polar extreme to the other.”
If an epidemiological breakthrough changes the trajectory of the pandemic, a surge of stimulus on top of that could supercharge the economy to the extent that prices rise quickly.
The risk the Fed runs is that if an epidemiological breakthrough changes the trajectory of the pandemic, a surge of stimulus on top of that could supercharge the economy to the extent that prices rise quickly. This would pressure the Fed to revisit its stance on not raising interest rates sooner than it — and Wall Street — had planned, a recipe for market volatility.
Although skyrocketing inflation is possible — if unlikely — derailing a fragile economy with higher interest rates too soon is by far a greater threat to the recovery, Gagger said. “The Fed would rather be late than early.”
Mark Heppenstall, chief investment officer of Penn Mutual Asset Management, said the Fed’s recent move to characterize its 2 percent inflation target as an average figure to be achieved over time gives officials more discretion when it comes to rate adjustments.
“I think that allows them a lot of flexibility, partly because we’ve been running below 2 percent for so long. At least for the time being, I think inflation isn’t going to be the primary area of focus,” he said.
“To me, it’s a bit too early to start talking about it,” Heppenstall said, since the Covid-19 vaccine has yet to be widely available and distributed, and the emergence of new, more contagious strains of the coronavirus weigh on the nation’s reopening efforts. “I don’t think, until the pandemic is more fully out of our lives, will we begin to talk about it.”
Charlie Ripley, senior investment strategist for Allianz Investment Management, said Powell has to thread a needle in terms both of policy and how he communicates the Fed’s rationale behind those decisions. “We expect the Fed to continue to reiterate previous messages and signal to the market that the accommodative policy stance is in place for the foreseeable future,” he said.
Ripley said Powell is likely to stick to that narrative — going off-script can blindside Wall Street and throw cold water on investor confidence. In 2013, when then-Chair Ben Bernanke announced plans to taper the Fed’s quantitative easing program, markets were briefly thrown into disarray. “The last thing that Powell wants to see is a repeat of the 2013 taper tantrum when the economy is in recovery mode,” Ripley said.
“Maybe once vaccines get greater distribution, we’ll have a lot more flexibility there,” Giannotto said. “If they precipitate a loss of confidence, that’s far more difficult to try to repair.”