Fed Hawks Are Endangered in the Covid Slowdown
2020-07-28 | Since 2 Month
John Authers
John Authers

It seems odd for familiar rhythms to continue in the time of Covid, but Wednesday will bring the latest announcement from the Federal Open Market Committee. It is easy to forget because, after some of the most dramatic months in central banking history, there is little question about what the Fed will do.
A chart from NatWest Markets, illustrates things perfectly. In the chart, the top two quadrants are for the hawkish members of the FOMC, while the bottom two are for the doves. All are dovish, with Chairman Jerome Powell and his deputy Richard Clarida right at the most dovish end of the scale.
This committee isn’t likely to spring a hawkish surprise. After single-handedly rescuing the markets earlier this year (we will find out about the consequences later), the Fed won't want to upset the apple cart. Lenient monetary policy is now taken for granted, while the critical actors are the health authorities, and the politicians who must decide on US fiscal policy. Covid-19 won’t allow the Fed to tighten for a while. Promising signs that the virus is coming under control in Arizona, and to a lesser extent in Florida and Texas, must be balanced by sharply increasing cases in a range of states in the south and Midwest, such as Alabama, Missouri and Wisconsin. Economic activity appears to be diminishing in affected areas, even without direct prodding from state governments.
Meanwhile, there is plentiful evidence that the resurgence of Covid has choked off an economic recovery. Labor market strength isn’t as great as hoped, making it acutely difficult for the Fed to tighten policy in any way. The US has seen a pleasantly surprising rebound in employment over the last few months, but that was only because it had previously suffered a particularly severe hit. This shows up clearly in international comparisons. The exercise, produced by Deutsche Bank AG foreign-exchange strategist Alan Ruskin, shows that only the Philippines has suffered a greater increase in unemployment since the end of last year.
Real-time surveys suggests a renewed slowdown in US employment. Claims data last week showed that the number of lay-offs was rising again, having never come close to its levels before the outbreak. Unemployment data arrive with a lag, but real-time labor estimates produced by academics at Arizona State University and Virginia Commonwealth University aim to provide figures every other week, and to publish results the same week, reducing the delay. Their Real-Time Population Survey uses an online sample of the US working-age population.
One finding is that the proportion who are employed is falling again, after an initially encouraging rebound. Having reached a trough at 53.3%, this now stands at 59.4%.
Meanwhile, the picture for earnings is more concerning. Wages among those employed pre-Covid in February are barely any better now than they were three months ago, at the height of the initial lockdown. Almost 20% of those working in February aren’t employed, while about 13% are making do with significantly lower wages. This explains the importance of the negotiations over fiscal policy.
The survey also confirms two other disquieting trends. First, the Covid slowdown has been worse for women than for men (although the most recent downturn seems to have affected men slightly more).
There is little to no chance that the Fed will do anything hawkish in these conditions. For the future, it will need to decide on any revisions to its policy of forward guidance. As Bloomberg Opinion columnist Tim Duy explained earlier this month, the Fed might well signal that it is prepared to tolerate an inflation overshoot, at least until some specific rate of employment has been reached.
Recent history demonstrates that the Fed has had extreme difficulty getting inflation up to its target. A chart from Steven Englander of Standard Chartered Plc shows that by the Fed’s favored measure of inflation, the undershoot is getting wide indeed. Englander points out that this leaves lots of room for an intentionally vague new target. For example, if the Fed were to aim for an average 2% inflation rate over the cycle, but be unclear as to when the cycle started, there would be room to allow a very big overshoot.
It could also attempt to control the yield curve, or to stoke further asset purchases. But for the time being, it is hard to see how Powell can do much more than emphasize that the Fed will have to be guided by the state of progress in fighting the pandemic. As the movement in real-time employment measures makes clear, there is too much medical uncertainty for the Fed to take any confident position. And it also needs to wait to find out how elected politicians choose to support a labor market that sadly is still very much in need of assistance.

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