- Broad market functionality is much improved despite the uncertain economic outlook, thanks in large part to the actions of monetary and fiscal policymakers
- Economic forecasting is as challenging as ever, and the Citigroup Economic Surprise Index posted both the highest and lowest levels on record within a 2-month period
- Fed leaders have made it clear that there are no plans to reduce the current level of monetary accommodation anytime soon; Yield curve control is being discussed as another potential tool
All things considered, financial markets have performed very well in recent months amid extraordinary monetary and fiscal aid, but the economic outlook became even less certain in the second half of June. Many state and local leaders began to loosen restrictions on businesses and shelter-in-place orders in early May, which was well received by risk markets. However, a resurgence in new COVID cases and hospitalizations in many populous states is causing political leaders to reconsider those easements. In Texas, for example, Governor Greg Abbott has once again closed bars, as well as rolled back easements on restaurants and other businesses. While a willingness to broadly reinstitute the lockdowns of March and April doesn’t yet appear imminent, an inability to slow this recent trend in the near term may fuel greater concern in financial markets that fresh lockdowns are coming.
Just as the virus has been difficult to predict (and contain), forecasting the ultimate path of the recovery has been equally challenging for economists. Exhibit 1 looks at the Citigroup Economic Surprise Index, which tracks actual economic data relative to market expectations on a daily basis. In other words, did the data surprise to the upside or downside? A positive index reading infers the former and a negative reading the latter. Notice the wild swing in the index over the last few months. The index tracks data going back to January 2002, and the record low (April 30) and record high (June 30) were reached within two months of each other. It’s yet another example of extreme volatility in the current environment, and there’s been multiple forecast misses by the economist community, most notably the retail sales and jobs reports for the month of May. Both reports were significantly better than expectations, and while economic forecasters were made to look silly, this is one of, if not the, most unique economic environments ever experienced. As such, we would be careful about focusing too much on economic outlooks, including the alphabet soup of recovery trajectories (V-shaped, U-shaped, etc.). There is simply too much uncertainty at this point.
The Fed Settles In
If it wasn’t understood already, the June 10 FOMC meeting made it abundantly clear that the Fed has no intention of changing its current course anytime soon. In the official statement, the FOMC pledged to continue its Treasury, MBS, and ACMBS purchases “at least at the current pace to sustain smooth market functioning.” In other words, Treasury and MBS purchases are floored at the current pace of $80 billion and $40 billion per month, respectively, until further notice from the committee.
The FOMC also released its first updated Summary of Economic Projections (SEP) since December. It typically releases updates on a quarterly basis, but given the turmoil and uncertainty in March, the committee decided to defer its release. The June release was much anticipated, particularly as it related to the FOMC’s outlook for the recovery relative to interest rate policy. As illustrated in Exhibit 2, the median forecast for year-end 2020 GDP growth is -6.5%, a drastic difference from the pre-virus projection of 2% last December. However, the median projection jumps to 5% for 2021 and 3.5% for 2022, both well above the longer-run trend growth rate of 1.8%. The median unemployment rate projection is back to single digits by year end and 5.5% by the end of 2022, the latter of which is still 1.4% above its longer-run trend rate. However, what was most focused on by market participants (for better or for worse) was the median projection for the fed funds rate, which showed the Fed maintaining zero-interest rate policy (ZIRP) at least through 2022…
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