Jay Powell, Federal Reserve chairman, made no significant changes to monetary policy but pledged to do more to support the recovery if necessary © AFP via Getty Images

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The Federal Reserve has warned that the fate of the world’s largest economy would “depend significantly on the course of the virus” as the US central bank extended measures to deal with the risk of an international shortage of dollars.

After a two-day meeting on Wednesday, the Federal Open Market Committee made no significant changes to monetary policy, holding interest rates close to zero and pledging to do more to support the recovery if necessary.

Jay Powell, the Fed chair, expressed fears that increases in Covid-19 infections across many US states had started to hit the economy, citing “non-standard, high-frequency data” on credit card spending, employment, hotel occupancy, restaurant bookings and consumer surveys.

“The pace of the recovery looks like it has slowed since the cases began that spike in June,” Mr Powell said at a press conference following the meeting. “It’s too early to tell both how large that is and how sustained it will be. We just don’t know yet,” he added.

In an indication of concerns that the pandemic could stir fresh trouble in international financial markets in future, such as the dollar shortages that occurred early in the pandemic, the Fed said it would extend emergency swap lines with some central banks until the end of the first quarter of 2021, as well as a temporary repurchase facility for international monetary authorities to swap Treasuries for dollars.

“We want them to remain in place and be available as long as they are needed and, since the crisis and the economic fallout from the pandemic are far from over, we’re going to leave those in place for the time being,” Mr Powell said. “There’s nothing that’s going on in the market right now that raises any concerns, it’s just we want them to be there as a backstop for markets.”

The Fed’s meeting on monetary policy came as the dollar this week dropped to a two-year low after a surge in coronavirus cases nationwide prompted investors to lose confidence in the sustainability of the US economic recovery that began haltingly in May. Its slide picked up pace as Mr Powell spoke.

The dollar index, which measures the currency against a basket of peers, fell 0.5 per cent, before coming back slightly, bringing its monthly losses to about 4 per cent. At the same time, gold prices soared to new highs, trading at $1,973 an ounce at one point.

Demand for haven assets also sent short-dated US Treasury yields lower, indicating a rise in price. The yield on the more policy-sensitive two-year note now sits at 0.13 per cent, while benchmark 10-year Treasury yields were flat at 0.58 per cent. 

Line chart of USD index, showing US dollar has extended its slide to a two-year low

Real yields on US Treasuries, which strip out expectations of consumer price movements from the nominal yield on bonds, have also continued to fall, sliding to levels last seen in 2012. Investors attributed the move to heightened expectations that a souring economic outlook will force the Fed to keep monetary policy accommodative for the foreseeable future. 

US stocks added to earlier gains after the announcement, with the S&P 500 rising more than 1 per cent.

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According to Peter Tchir, chief macro strategist at Academy Securities in New York, the robust recovery the Fed has been able to engineer across financial markets since March has meant there is less need at the moment for additional support.

“It would be highly unusual, given where stocks, bonds and credit markets are, for them to be more aggressive now,” he said. “I find it hard to believe they can say much to give the market more confidence in what they are doing than they already have.”

In the run-up to the FOMC meeting, in a series of public interventions, some Fed officials had been warning that fresh virus outbreaks were posing a threat to the US recovery from the initial shock delivered by the pandemic and its lockdowns.

But the FOMC’s statement on the economic trajectory’s dependence on the virus was new, compared to its previous language, and Mr Powell fleshed it out during his press conference.

“The path of the economy is going to depend to a very high extent on the course of the virus and on the measures that we take to keep it in check,” he said. “That is just a very fundamental fact about our economy right now. The two things are not in conflict.”

“Social-distancing measures and fast reopening of the economy, they actually go together, they are not in competition with each other,” Mr Powell added.

Since the crisis began, the Fed slashed its main interest rate close to zero, expanded its balance sheet sharply through open-ended asset purchases, and set up credit facilities to support markets. It has been debating ways to support the economy further, including by strengthening its commitment to low interest rates until certain macroeconomic milestones on inflation or unemployment are met.

But the central bank did not make any change on Wednesday, and instead repeated its pledge to “use its tools and act as appropriate to support the economy”. Mr Powell hinted that a decision on strengthening forward guidance could be contingent on the Fed finishing a long-running review of its monetary policy tools, which would be completed in the “near future”.

This could lead to a change in policy as early as September, but not necessarily, and Mr Powell did not commit to any specific timeframe, nor did he say which options for enhancing stimulus were preferable. “We haven’t made any decisions on that, so I wouldn’t be standing here telling you we’re going to go this way or that way, should the time come for us to change our forward guidance.”

The decision to extend dollar swap lines applies to the central banks of Australia, Brazil, South Korea, Mexico, Singapore, and Sweden, as well as Denmark, Norway and New Zealand. The Fed has permanent standing swap line arrangements with key central banks such as the ECB, the Bank of Japan, the Bank of England and the Bank of Canada. The announcement on Tuesday that it would extend the emergency credit facilities it set up during the pandemic until the end of the year was another sign of its worry that the economic and financial fallout would continue.

The Fed has been counting on Congress to help keep the recovery alive by injecting a new round of fiscal stimulus into the economy, on top of $3tn in measures approved early in the crisis in March and April. But with just days left before the expiry of emergency jobless benefits worth $600 per week to unemployed workers, the White House and its Republican allies on Capitol Hill are still at odds with Democratic lawmakers over the size and details of any new package.

“The fiscal policy actions that have been taken thus far have made a critical difference to families, businesses, and communities across the country,” Mr Powell said.

“Even so, the current economic downturn is the most severe in our lifetimes. It will take a while to get back to the levels of economic activity and employment that prevailed at the beginning of this year, and it will take continued support from both monetary and fiscal policy to achieve that,” he concluded.


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