How does the federal funds rate affect the global economy? | IG Explainers
Federal Reserve officials pressured Congress to influence the allocation of additional financial aid to the US economy, for good reason: the central bank is running out of ways and means to help.
With the expiration of key provisions of the $ 2.2 trillion CARES Act, which Congress extended in March, the Fed is once again relied on as a key support system for the economy. The central bank has maintained extremely soft policies, while continuing to offer its lending and market stimulation programs, and has now decided that it probably will not raise short-term interest rates for many years..
While no Fed official will ever admit that the ammunition for monetary policy is running out, and in fact insists on the opposite, it seems that there are not many shells left in the Fed’s arsenal..
«What they have left is really on the edge», – said Mark zandi (Mark Zandi), Chief Economist at Moody’s Analytics. «They simply have no room to maneuver on monetary policy. I really don’t understand what else they can do. This is why they are so explicitly calling on the fiscal authorities to do more, because they know they can do nothing.».
Indeed, the chairman Jerome powell and other officials rarely miss an opportunity to ask Congress for more help.
Powell said earlier in October in a speech to the National Association of Business Economists that the delay in providing additional funds to bail out can «lead to a weak recovery, creating unnecessary hardships for households and businesses». He stressed that the greater risk would be low financial aid, adding that «the risks of overdoing it seem lesser at the moment».
Also this month, the head of the Fed Lael Brainard (Lael Brainard), who is considered the likely next finance minister if Joe biden will become president, said that the inability Congress to agree represents «the most significant risk of deterioration» its economic forecast.
Fed from time to time give their officials on fiscal policy, but this does not happen often. Former Fed Chairman Ben bernanke (Ben Bernanke) warned lawmakers about «fiscal cliff», at which the term of the key aid expires, and its successor Janet Yellen (Janet Yellen) also sometimes stressed the need for strong fiscal policy.
For his part, Powell warned more often before the pandemic about the unsustainable path of fiscal policy on debt and deficits. This is no longer the case as the number of coronavirus infections continues to rise and the economy struggles to return to its pre-Covid-19 state..
The Fed still has several options to help the economy bolster the liquidity programs it itself instituted, which in turn helped the markets run smoothly after the March unrest..
If spreads between bond yields begin to widen, a classic sign of financial stress, the Fed could take «control of the yield curve» by buying bonds. The regulator could also accelerate the pace of bond purchases and could further strengthen recommendations on what needs to be done to raise interest rates..
At the moment, it all looks like rather boring tools..
Government bond yields are already at historic lows, and Fed officials themselves are skeptical about the yield curve control tool.
Thus, the severity of the Fed’s requests for additional financial assistance is a reflection of how limited the capacity of the central bank is..
«Nothing new here, said Zandi. «There is nothing they can do to help the economy in the near future.».
The Fed’s biggest weapon right now is a marked change in its approach to inflation. The new regime includes targeting average inflation, with the practical impact that the Fed will allow inflation to exceed 2% for a certain period of time to account for the current period, that is, in fact, for the past eight years when she has not reached this target.
However, even this effect has limitations..
With everyone already pretty much expecting the Fed to stay in place for years, a repetition of this stance offers little relief in the event that investors get nervous and the economy starts to hesitate. In fact, a mid-inflation approach is likely to have a greater impact when the economy is strengthening, rather than when it is weak, said Krishna guha (Krishna Guha), Head of Global Policy and Strategy, Central Bank, Evercore ISI.
«These recommendations will have a much stronger impact in the face of positive shocks, when the economy deepens into expansion, than in the current environment, when the Fed will not raise rates in any case.», – Guha said in a note.
Importantly, Guha added that the impact of inflation targeting itself «would be much lower without financial cooperation, in part because the central bank cannot target the worst-hit sectors».
The Fed could also work with its lending programs, but most of them have been little used, so easing conditions or expanding purchases of corporate bonds will probably also help only on the periphery of the economy..
Of course, there’s always a chance the Fed won’t even be asked for much..
On Thursday, the government released its first estimate of third-quarter GDP, and the growth rate could reach 36.2%, according to an updated estimate released by the Atlanta Fed on Tuesday. Unexpected surge in long-term capital goods orders on Tuesday, vital housing market and CEO’s upbeat sentiment all indicate the possibility of long-term US expansion..
However, many economists, including those from the Fed, do not expect the pace to remain close to the pace of the third quarter. Federal Open Markets Committee predicts 4% growth in 2021, which would be exceptional under normal circumstances, but in this case could still lead to the fact that the United States does not reach pre-pandemic levels.
The wild card in this situation, of course, is the progression of the coronavirus. If the number of cases continues to increase and activity decreases, it will further complicate the situation for the Fed, especially without increasing government spending..
«The need for incentives has become even more important than when the Fed started the synchronous song about fiscal measures», – said Quincy crosby (Quincy Krosby), Chief Market Strategist at Prudential Financial. «What was interesting about this was that it came from both the hawks at the Fed and the pigeons at the Fed. It was completely synchronized, consistent and almost continuous chanting.».
Left alone, the Fed may next time speed up asset purchases that have traditionally been a boon to the stock market but have recently stopped. In the four months from March to June, when the pandemic began, the Fed’s balance sheet grew 66% to $ 7.13 trillion.
In the four months since then, growth was only 1.3%, although Fed officials stressed that they will continue to buy Treasury bonds and mortgage-backed securities, at least at the current pace..
«The Fed is really the only hope, said Nick marutsos (Nick Maroutsos), Head of Global Bonds Janus Henderson. «As for the fact that they ran out of ammunition, I think we are far from that. They have many more tools to use.».
Marutsos sees the likelihood of additional incentives combined with compliant Fed seeking to keep rates low as a healing balm for a market that has recently become volatile due to fears that economic growth in the third quarter may be thwarted.
«Fed is temporarily suspended for at least 4-5 years, maybe more. This Fed rate is valid from now to infinity», – he said. «It feels like they are encouraging people to buy risky assets, and this will continue because it is not in the Fed’s best interest to let yields rise.».