The final package could well reflect a bill published last week by a bi-partisan group of senators which included some relief for small businesses, some enhancement to unemployment benefits, some further money for state and local governments and an extended moratorium on foreclosures. However, these measures are unlikely to be enough to prevent further layoffs in both the public and private sectors and significant financial distress for shuttered small businesses and the more than nine million Americans who have swelled the unemployment rolls or left the labor force since February.
On Wednesday, the Federal Reserve will conclude their last meeting of the year. In their post-meeting statement they may note both the negative economic impact of a worsening pandemic in the short run and greater hopes for a vaccine boosting economic fortunes in 2021. In their forecasts, they will likely increase their near-term assessments of economic growth, reduce their projections for unemployment and, possibly, raise their assessments of inflation slightly for 2021. Despite this, they will likely still see the unemployment rate running above 4.0% until 2023 and still signal their intent to hold short-term interest rates at current levels through the end of that year.
Their position on asset purchases, however, may be somewhat more nuanced. The Fed may extend the duration of its bond purchases with an aim to suppress long-term interest rates. They could also commit to buying Treasuries in current or greater amounts until the pandemic has ceased to be an economic threat. While this sounds appropriate, if markets begin to believe in a slightly earlier-than-feared end to the pandemic, they may also begin to anticipate an earlier-than-expected tapering of bond purchases. This anticipation could drive 10-year Treasury yields above 1.0% within the next few weeks.
But of course, like a concerned parent, the Fed could be tempted to do more. It could expand current bond purchases in a more significant manner to make up for a lack of fiscal stimulus. The Fed could also recommit to running a very easy monetary policy even further into the expansion. Such a commitment could well put further downward pressure on the dollar, boosting both our exports and the dollar value of international stocks and bonds. However, as was the case in the last decade, ultra-easy monetary policy is more likely to boost asset prices than economic output. In addition, super-easy monetary policy could, indirectly, worsen inequality while simultaneously increasing the risk of an eventual financial crisis.
In his post-meeting remarks, Fed Chairman Jay Powell will likely, once again convey understanding, empathy and a determination to do everything in the Fed’s power to help offset the impact of the pandemic on ordinary citizens. However, he would do well to emphasize that a quick exit from the pandemic and the misery it has caused depends primarily on fiscal actions taken in Washington and our collective determination to observe common sense health protocols. Investors should, however, watch the Fed’s messaging very carefully. If the Fed signals that it feels compelled to act more aggressively to compensate for a lack of focus in Washington or discipline among the general public, investors should be positioned for continued low interest rates and a lower dollar in the short run and the risk of higher inflation and greater fiscal stress when the pandemic is finally in the rear view mirror.
David Kelly is chief global strategist at JPMorgan Funds.