Explainer: What to look for in the Fed’s U.S. economic outlook

By Ann Saphir

SAN FRANCISCO (Reuters) – U.S. Federal Reserve policymakers on Wednesday will publish their first economic projections since the coronavirus pandemic set off a recession in February, estimates expected to signal a collapse in output this year and near-zero interest rates for the next few years.

They’ll also give shape to the range of views at the U.S. central bank about the expected speed of the recovery and any longer-term damage to the world’s biggest economy from a pandemic that has so far killed nearly 111,000 Americans and prompted unprecedented restrictions on commerce and movement to slow its spread.

Here is a guide to what the projections may show and what questions they may raise about the future of the U.S. economy as authorities lift those restrictions.

WHAT ARE THEY?

Every three months, each of the Fed’s 17 policymakers develops a set of multi-year forecasts for U.S. unemployment, inflation, economic growth and interest rates. The projections are published in summary form at the end of the policy-setting meeting. The Fed did not release a quarterly summary of economic projections in March, however, because of massive uncertainty about the spread of the novel coronavirus, the resulting lockdowns, and the economic fallout. Though plenty is still uncertain, one thing is clear: the projections on Wednesday will be starkly worse than the Fed’s largely favorable outlook in December. (Please see graphic )

DOES THIS HAVE ALL THOSE DOTS?

Yes. The projections’ centerpiece is the so-called dot plot, a graphic representation of where each unnamed policymaker sees interest rates in coming years. This collection of rate-setters’ individual views has also occasionally functioned as a loose policy promise about the path of rates. This is one of those times. The Fed has signaled it will keep its key overnight lending rate near zero until the recovery is well underway. The dots, which will likely show most Fed policymakers expect no change in rates through 2022, “could be seen as a soft way of reinforcing that guidance,” said Michael Feroli, chief U.S. economist at JP Morgan.

HOW DEEP, HOW LONG?

With states in various stages of reopening after weeks or more of stay-at-home orders that precipitated the recession, the Fed policymakers’ forecasts will map their sense of how quick the recovery will be.

“The Fed likely forecasts a strong rebound in growth in H2, but the level of GDP will remain well below the pre-coronavirus level until late 2021” Oxford Economics’ Kathy Bostjancic wrote. Her view was widely echoed by other economists.

The U.S. unemployment rate, which fell unexpectedly to 13.3% in May, may be projected to end this year in double digits and remaining well above healthy long-run levels next year. The Fed will likely project inflation to undershoot its 2% target for the foreseeable future, Bostjancic and others say.

Importantly, the Fed’s summary of projections reflects what policymakers see as the most likely path for the economy, which for many does not factor in a second wave of infections – a key unknown for now.

But deaths from COVID-19, the respiratory illness caused by the novel coronavirus, continue to increase in many U.S. states, and public health officials have flagged the possibility of further spread after crowded Memorial Day celebrations in parts of the country in late May and ongoing mass protests against racial inequalities since the May 25 death of George Floyd, a black man, in police custody in Minneapolis.

“The risk to our forecast, and likely the Fed’s, is skewed to the downside,” Bostjancic said.

LONG-TERM DAMAGE?

The economic projections being released on Wednesday will also offer insight into whether Fed officials see the pandemic as inflicting permanent damage on the economy. Nomura economist Lewis Alexander projects little change to the Fed’s earlier estimate that the economy can sustain about 1.9% yearly growth in the long run, along with 4.1% unemployment, though both could erode. More broadly, he said, “it is important to emphasize the significant amount of uncertainty” around the forecasts.

(Reporting by Ann Saphir; Editing by Dan Burns and Paul Simao)

What did eight weeks and $3 trillion buy the U.S. in the fight against coronavirus?

By Howard Schneider

WASHINGTON (Reuters) – Unemployment checks are flowing, $490 billion has been shipped to small businesses, and the U.S. Federal Reserve has put about $2.5 trillion and counting behind domestic and global markets.

Fears of overwhelmed hospitals and millions of U.S. deaths from the new coronavirus have diminished, if not disappeared.

Yet two months into the United States’ fight against the most severe pandemic to arise in the age of globalization, neither the health nor the economic war has been won. Many analysts fear the country has at best fought back worst-case outcomes.

For every community where case loads are declining, other hotspots arise and fester; for states like Wisconsin where bars are open and crowded, there are others such as Maryland that remain under strict limits.

There is no universal, uniform testing plan to reveal what is happening to public health in any of those communities.

Between 1,000 and 2,000 people a day continue to die from the COVID-19 disease in the United States, and between 20,000 and 25,000 are identified as infected.

If there is consensus on any point, it is that the struggle toward normal social and economic life will take much more time, effort and money than at first thought. The risks of a years-long economic Depression have risen; fact-driven officials have become increasingly sober in their outlook, and the coming weeks and coming set of choices have emerged as critical to the future.

Faced with two distinct paths – a cavalier acceptance of the mass deaths that would be needed for “herd immunity” or the truly strict lockdown needed to extinguish the virus – “we are not on either route,” Harvard University economist James Stock, among the first to model the health and economic tradeoffs the country faces, said last week.

That means no clear end in sight to the economic and health pain.

“I am really concerned we are just going to hang out. We will have reopened across the board, not in a smart way … and we will have months and months of 15% or 20% unemployment,” Stock said. “It is hard to state how damaging that will be.”

TAKING STOCK

Treasury Secretary Steven Mnuchin and Fed chair Jerome Powell will appear via a remote internet feed before the Senate Banking Committee on Tuesday to provide the first quarterly update on the implementation of the CARES Act, which along with a follow-up bill formed the signature $2.9 trillion legislative response to the pandemic. (See a graphic  of the full stimulus.)

They will likely face detailed questions about their efforts after a rocky few months. The Paycheck Protection Program, in particular, was originally overwhelmed with applicants and criticized for hundreds of loans doled out to publicly traded companies.

Yet, now two months in, a replenished program still has $120 billion in funding available – money on the table that analysts at TD Securities suggest people have refused to pick up because of confusion about the terms.

The hearing is also likely to be a platform for Democrats to coax Mnuchin and Powell toward acknowledging that more must be done – Powell said so directly in an appearance last week – and for Republicans arguing against quick new action.

DEATH PROJECTIONS DOWN, TESTING UP

The lockdowns and money have had an impact on the disease’s spread, as the postponement of sporting events and other mass gatherings, and restaurant and store closings curbed the spread of a virus that some early estimates saw killing as many as 2 million Americans.

Deaths as of Saturday stood at around 87,000 and are expected to pass 135,000 by early August. (Graphic )

After federal government missteps and delays, testing has ramped up to 1.5 to 2 million tests a day, still less than half what health experts say the country needs. (Graphic )

Strict lockdowns slowed the rate of infection in the hardest-hit areas, “flattening the curve” so hospitals could retrain nurses, cobble together donations of personal protective equipment such masks, gloves and gowns, and were spared from the direst predictions about intensive care shortages.

However, the fight against the coronavirus may still be in its initial stages in more than a dozen U.S. states, where case numbers continue to rise. (Graphic )

And community agencies are noting increases in cases of domestic violence and suicide attempts after weeks of home confinement.

TRILLIONS MORE SPENDING AHEAD?

At its passage in late March the CARES Act was regarded as a major and perhaps sufficient prop to get the U.S. economy through a dilemma.

Fighting the spread of the virus came with a massive economic hit as stores closed, transportation networks scaled back, and tens of millions of people lost jobs or revenue at their businesses. (See a graphic of the economic fallout.)

Facing a decline not seen since the Great Depression of the 1930s, the main goal of the bill was to replace that lost income with checks to individuals and loans to small businesses that are designed to be forgiven.

JPMorgan economist Michael Feroli estimated recently that the loans and transfer payments under the act turned what would have been an annualized blow to income of nearly 60% from April through June into an annualized decline of 15% – sharp, but far more manageable.

GDP in the second quarter, however, will drop 40% on an annualized basis. The budget deficit this fiscal year is expected to nearly quadruple to $3.7 trillion.

Some of the deadlines in the CARES Act are approaching. The small business loans were meant to cover eight weeks of payroll, a period that has already lapsed for companies that closed in mid-March when President Trump issued a national emergency declaration. The enhanced $600 per week unemployment benefit expires at the end of July.

The House on Friday passed a new $3 trillion CARES Act to replenish some funding, but it is unclear whether the Republican-led Senate will take it up.

Weeks after a V-shaped economic recovery was predicted in March, most economists and health officials have a darker message.

“It is quite possible this thing will stay at however many deaths it is a day indefinitely, just wobbling up and down a little bit as epidemics move to different places around the country,” said economist and Princeton University professor Angus Deaton.

“The sort of social distancing we are prepared to put up with is not going to do very much.”

(Reporting by Howard Schneider; Additional reporting by Susan Cornwell; Editing by Heather Timmons and Daniel Wallis)

Coming next from the Fed: How much for Main Street?

By Howard Schneider

WASHINGTON (Reuters) – The U.S. Federal Reserve responded fast to the coronavirus crisis with open-ended programs to keep financial markets running and ensure major companies could raise cash as they usually do through large capital markets.

By forcing major parts of the economy to simply stop operating, however, the current crisis poses a direct threat to the hundreds of thousands of small and medium-sized businesses that don’t raise money by issuing stocks or bonds, but rely on myriad combinations of bank loans, owner’s capital and, in some cases, personal credit cards or home equity loans.

The Fed, in coordination with the Treasury Department, is planning a Main Street Lending Facility as one of its linchpin programs in the crisis. U.S. Treasury Secretary Steven Mnuchin said on Wednesday he hoped to announce details of the program this week.

Ahead of that, the following summarizes what is known about the Main Street program and what analysts who watch the Fed closely think it might look like:

WHO WILL PAY FOR IT?

In the $2.3 trillion emergency response bill enacted on March 27, $454 billion is set aside for the U.S. Treasury to use for new programs at the Fed, including the one for “Main Street.”

HOW BIG WILL IT BE?

This is the crisis where “trillions” have become the go-to denomination. Joseph Brusuelas, an economist with business consulting firm RSM who has followed the Fed’s crisis response closely, expects the Fed to receive an $85 billion capital contribution from Treasury and turn that into $1 trillion of lending power for businesses.

HOW DOES THE FED DO THAT?

The Fed gets its punch through “leverage,” or taking a given amount of money from Treasury and allowing financial institutions to create perhaps 10 times that amount in credit. The Fed is not supposed to take losses, since that would amount to laying out taxpayers’ money that it is not authorized to spend. But most loans don’t go bad: in effect every dollar provided by Treasury allows many more dollars of lending, because most of it will be repaid. The Treasury’s funds are there to cover only the small portion expected to go bad.

HOW WILL IT WORK?

The Fed is restricted from lending directly to companies or individuals. But it can provide financing to a “special purpose vehicle” that then either lends to or buys assets from, say, a bank that does provide business and consumer loans. Because those lending institutions now know they can send the loans to the SPV, they are willing to make deals with companies and consumers even in a risky environment. Cornerstone Macro analyst Roberto Perli said the Fed’s SPV could either buy loans directly, one at a time, from banks, or have banks bundle them into larger securities.

WHO WILL BE ELIGIBLE?

This may be the most difficult issue. Large companies get credit ratings from independent agencies such as Standard & Poor’s or Moody’s, and the Fed has used those credit ratings to draw a line around which companies are eligible for its programs. For “Main Street” lending, the Fed may have to lean on banks to assess the finances of midsize companies and sift those struggling only because of the coronavirus from those that were struggling anyway. The focus may be on firms with 500 to 10,000 employees, since those below the cutoff can get small business loans and those above it typically use the capital markets. As of early 2019 there were about 18,000 companies with more than 500 workers – including more than 2,000 midsize manufacturers that are an important piece of the U.S. industrial base.

(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)

WHO warns of global shortage of medical equipment to fight coronavirus

By Andrea Shalal and Stephanie Nebehay

WASHINGTON/GENEVA (Reuters) – The World Health Organization (WHO) on Tuesday warned of a global shortage and price gouging for protective equipment to fight the fast-spreading coronavirus and asked companies and governments to increase production by 40% as the death toll from the respiratory illness mounted.

Meanwhile, the U.S. Federal Reserve cut interest rates on Tuesday in an emergency move to try to prevent a global recession and the World Bank announced $12 billion to help countries fight the coronavirus, which has taken a heavy toll on air travel, tourism and other industries, threatening global economic growth prospects.

The virus continued to spread in South Korea, Japan, Europe, Iran and the United States, and several countries reported their first confirmed cases, taking the total to some 80 nations hit with the flu-like illness that can lead to pneumonia.

Despite the Fed’s attempt to stem the economic fallout from the coronavirus, U.S. stock indexes closed down about 3%, safe-haven gold rose 3% and analysts and investors questioned whether the rate cut will be enough if the virus continues to spread.

U.S. lawmakers were considering spending as much as $9 billion to contain local spread of the virus.

In Iran, doctors and nurses lack supplies and 77 people have died, one of the highest numbers outside China. The United Arab Emirates announced it was closing all schools for four weeks.

The death toll in Italy, Europe’s hardest-hit country, jumped to 79 on Tuesday and Italian officials are considering expanding the area under quarantine. France reported its fourth coronavirus death, while Indonesia, Ukraine, Argentina and Chile reported their first coronavirus cases.

About 3.4% of confirmed cases of COVID-19 have died, far above seasonal flu’s fatality rate of under 1%, but the virus can be contained, the WHO chief said on Tuesday.

“To summarize, COVID-19 spreads less efficiently than flu, transmission does not appear to be driven by people who are not sick, it causes more severe illness than flu, there are not yet any vaccines or therapeutics, and it can be contained,” WHO chief Tedros Adhanom Ghebreyesus said in Geneva.

Health officials have said the death rate is 2% to 4% depending on the country and may be much lower if there are thousands of unreported mild cases of the disease.

Since the coronavirus outbreak, prices of surgical masks have increased sixfold, N95 respirators have tripled in cost and protective gowns cost twice as much, the WHO said.

It estimates healthcare workers each month will need 89 million masks, 76 million gloves and 1.6 million pairs of goggles.

The coronavirus, which emerged in the central Chinese city of Wuhan late last year, has spread around the world, with more new cases now appearing outside China than inside.

There are almost 91,000 cases globally of which more than 80,000 are in China. China’s death toll was 2,943, with more than 125 fatalities elsewhere.

In a unanimous decision, the Fed said it was cutting rates by a half percentage point to a target range of 1.00% to 1.25%.

Finance ministers from the G7 group of rich countries were ready to take action, including fiscal measures where appropriate, Japanese Finance Minister Taro Aso said. Central banks would continue to support price stability and economic growth.

AGGRESSIVE CONTAINMENT

In the United States, there are now over 100 people in at least a dozen states with the coronavirus and nine deaths, all in the Seattle area.

New York state reported its second case, a man in his 50s who works in Manhattan and has been hospitalized.

The public transportation agency in New York, the most densely populated major U.S. city of more than 8 million, said on Twitter it was deploying “enhanced sanitizing procedures” for stations, train cars, buses and certain vehicles.

China has seen coronavirus cases fall sharply, with 129 in the last 24 hours the lowest reported since Jan. 20.

With the world’s second largest economy struggling to get back on track, China is increasingly concerned about the virus being brought back into the country by citizens returning from new hotspots elsewhere.

Travelers entering Beijing from South Korea, Japan, Iran and Italy would have to be quarantined for 14 days, a city official said. Shanghai has introduced a similar order.

The worst outbreak outside China is in South Korea, where President Moon Jae-in declared war on the virus, ordering additional hospital beds and more masks as cases rose by 600 to nearly 5,000, with 34 deaths.

WHO officials also expressed concerns about the situation in Iran, saying doctors lacked respirators and ventilators needed for patients with severe cases.

WHO emergency program head Michael Ryan said the need in Iran was “more acute” than for other countries.

While the case numbers in Iran appear to be bad, he said, “things tend to look worse before getting better.”

The International Olympic Committee on Tuesday said the summer games in Tokyo set to begin on July 24 were still expected to happen despite Japan having nearly 1,000 coronavirus cases and 12 deaths. Health officials said they would continue to monitor the situation in Japan before any final decision on the Olympics is made.

Interactive graphic tracking global coronavirus spread: https://graphics.reuters.com/CHINA-HEALTH-MAP/0100B59S39E/index.html

(Reporting by Andrea Shalal in Washington and Tetsushi Kajimoto in Tokyo; Additional reporting by Michael Nienaber in Berlin, Stephanie Nebehay in Geneva, Kate Kelland in London, Takahiko Wada in Tokyo; Writing by Robert Birsel, Nick Macfie and Lisa Shumaker; Editing by Alexander Smith, John Stonestreet and Bill Berkrot)

Fed says risks to economy easing, but calls out coronavirus in report to Congress

By Howard Schneider and Lindsay Dunsmuir

WASHINGTON (Reuters) – A “moderately” expanding U.S. economy was slowed last year by a manufacturing slump and weak global growth, but key risks have receded and the likelihood of recession has declined, the U.S. Federal Reserve reported in its latest monetary policy report to the U.S. Congress.

“Downside risks to the U.S. outlook seem to have receded in the latter part of the year, as the conflicts over trade policy diminished somewhat, economic growth abroad showed signs of stabilizing, and financial conditions eased,” the Fed said, noting that the U.S. job market and consumer spending remained strong.

“The likelihood of a recession occurring over the next year has fallen noticeably in recent months.”

Among the risks the Fed did note: the fallout from the spreading outbreak of coronavirus in China, “elevated” asset values, and near-record levels of low-grade corporate debt that the Fed fears could become a problem in an economic downturn.

Overall, however, the Fed saw risks to a more than decade long U.S. recovery easing following its three interest rate cuts in 2019, and evidence that “the global slowdown in manufacturing and trade appears to be at an end, and consumer spending and services activity around the world continue to hold up.”

It cautioned that “the recent emergence of the coronavirus, however, could lead to disruptions in China that spill over to the rest of the global economy.”

By law the Fed twice a year prepares a formal report for the U.S. Congress on the state of the economy and monetary policy.

Much of its amounts to a review of recent events. The new document repeats the Fed’s assessment that the current level of the federal funds rate, in a range of between 1.5% and 1.75% was “appropriate” to keep the recovery track.

It also reviewed the spike in the federal funds rate last fall and the steps the Fed has taken to relieve funding pressures, repeating it considers the measures technical and not a change in monetary policy.

Fed Chair Jerome Powell will present the report at two public hearings next week, and some Democratic U.S. senators have already posed in writing a series of questions challenging the Fed’s actions in those short-term funding markets.

The document did include a separate section analyzing how a slump in manufacturing last year impacted economic growth overall, after concern a downturn in that sector might pull the United States into a recession.

The Fed concluded that the slowdown in factory output, which also meant less business for parts and services suppliers, cut overall growth in gross domestic product between 0.2 and 0.5 percentage points.

That falls “well short” of the threshold associated with past recessions, the Fed said.

(Reporting by Howard Schneider and Lindsay Dunsmuir; Editing by Andrea Ricci)

Fed cuts rates on 7-3 vote, gives mixed signals on next move

By Howard Schneider and Ann Saphir

WASHINGTON (Reuters) – The U.S. Federal Reserve cut interest rates by a quarter of a percentage point for the second time this year on Wednesday in a widely expected move meant to sustain a decade-long economic expansion, but gave mixed signals about what may happen next.

The central bank also widened the gap between the interest it pays banks on excess reserves and the top of its policy rate range, a step taken to smooth out problems in money markets that prompted a market intervention by the New York Fed this week.

In lowering the benchmark overnight lending rate to a range of 1.75% to 2.00% on a 7-3 vote, the Fed’s policy-setting committee nodded to ongoing global risks and “weakened” business investment and exports.

Though the U.S. economy continues growing at a “moderate” rate and the labor market “remains strong,” the Fed said in its policy statement that it was cutting rates “in light of the implications of global developments for the economic outlook as well as muted inflation pressures.”

With continued growth and strong hiring “the most likely outcomes,” the Fed nevertheless cited “uncertainties” about the outlook and pledged to “act as appropriate” to sustain the expansion.

U.S. stocks, lower ahead of the statement, dropped further, and Treasury yields ticked up from their lows of the day. The S&P 500 was last down 0.64% and the 10-year Treasury note yield inched up to 1.77%.

The dollar gained ground against the euro and yen.

“Another rate cut from the Fed to try to shield the U.S. economy from global headwinds,” said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington. “Today’s move was more of a hawkish easing in that the Fed’s median forecasts for rates suggested no more cuts this year, while some officials dissented.”

New projections showed policymakers at the median expected rates to stay within the new range through 2020. However, in a sign of ongoing divisions within the Fed, seven of 17 policymakers projected one more quarter-point rate cut in 2019.

Five others, in contrast, see rates as needing to rise by the end of the year.

The divisions were reflected in dissents that came from both hawks and doves.

St. Louis President James Bullard wanted a half-point cut while Boston Fed President Eric Rosengren and Kansas City Fed President Esther George did not want a rate cut at all.

There was little change in policymakers’ projections for the economy, with growth seen at a slightly higher 2.2% this year and the unemployment rate to be 3.7% through 2020. Inflation is projected to be 1.5% for the year, below the Fed’s 2% target, before rising to 1.9% next year.

Fed Chair Jerome Powell is scheduled to hold a press conference at 2:30 p.m. EDT (1830 GMT) to elaborate on the policy decision.

The rate cut fell short of the more aggressive reduction in borrowing costs that President Donald Trump had demanded from Fed officials, whom he has insulted as “boneheads” who have put the economic recovery in jeopardy.

The Fed also cut rates in July, the first such move since 2008.

Fed officials have said the rate cuts are justified largely because of risks raised by Trump’s trade war with China, a global economic slowdown and other overseas developments.

Their aim, they say, is to balance the potential need for lower rates against the risk that cheaper money may cause households and businesses to borrow too much, as happened in the run-up to the financial crisis more than a decade ago.

(Reporting by Howard Schneider and Ann Saphir; Additional reporting by Richard Leong in New York; Editing by Paul Simao and Dan Burns)

Explainer: The Fed has a repo problem. What’s that?

By Richard Leong

(Reuters) – As if the U.S. Federal Reserve didn’t already have enough on its plate heading into its meeting on interest rates this week, chaos deep inside the plumbing of the U.S. financial system has thrown policymakers an unexpected curveball.

Cash available to banks for their short-term funding needs all but dried up on Monday and Tuesday, and interest rates in U.S. money markets shot up to as high as 10% for some overnight loans, more than four times the Fed’s rate.

That forced the Fed to make an emergency injection of more than $50 billion, its first since the financial crisis more than a decade ago, to prevent borrowing costs from spiraling even higher. It will conduct another one on Wednesday.

The exact cause of the squeeze is a matter of some debate, but most market participants agree that two coincidental events on Monday were at least partly to blame. First, corporations had to withdraw funds from money market accounts to pay for quarterly tax bills, and then on the same day the banks and investors who bought the $78 billion of U.S. Treasury notes and bonds sold by Uncle Sam last week had to settle up.

On top of that, the reserves that banks park with the Fed and are often made available to other banks on an overnight basis are at their lowest since 2011 thanks to the central bank’s culling of its vast portfolio of bonds over the past few years.

Added together, these factors are testing the limits of the $2.2 trillion repurchase agreement – or repo – market, a gray but essential component of the U.S. financial system.

Whatever the cause, the episode has added fuel to the argument that the Fed needs to take steps to avoid more disruptions in the repo market down the road.

WHY IS THE REPO MARKET IMPORTANT?

The repo market underpins much of the U.S. financial system, helping to ensure banks have the liquidity to meet their daily operational needs and maintain sufficient reserves.

In a repo trade, Wall Street firms and banks offer U.S. Treasuries and other high-quality securities as collateral to raise cash, often overnight, to finance their trading and lending activities. The next day, borrowers repay their loans plus what is typically a nominal rate of interest and get their bonds back. In other words, they repurchase, or repo, the bonds.

The system typically hums along with the interest rate charged on repo deals hovering close to the Fed’s benchmark overnight rate, currently set in a range of 2.00% to 2.25%. That rate is expected to be cut by a quarter percentage point on Wednesday.

But sometimes, investors get fearful of lending, as seen during the global credit crisis, or at other times there are just not enough reserves or cash in the system to lend out, as appeared to be the case this week. And that can cause a squeeze on the market and send borrowing costs zooming higher.

But when investors get fearful of lending, as seen during the global credit crisis, or when there are just not enough reserves or cash in the system to lend out, it sends the repo rate soaring above the Fed Funds rate.

Trading in stocks and bonds can become difficult. It can also pinch lending to businesses and consumers and, if the disruption is prolonged, it can become a drag on a U.S. economy that relies heavily on the flow of credit.

WHAT HAS CAUSED THE DROP IN BANK RESERVES?

Coming out of the financial crisis, after the Fed cut interest rates to near zero and bought more than $3.5 trillion of bonds, banks built up massive reserves held at the Fed.

But that level of bank reserves, which peaked at nearly $2.8 trillion, began falling when the Fed started raising interest rates in late 2015. They fell even faster when the Fed started to cut the size of its bond portfolio about two years later.

The Fed stopped raising interest rates last year and cut them in July and is expected to do so again on Wednesday. It has also now ceased allowing to bonds to roll off its balance sheet.

The question vexing policymakers now is whether those actions are enough to stop the downward drift in reserves, which are a main source of liquidity in funding markets like repo.

Bank reserves at the Fed last stood at $1.47 trillion, the lowest level since 2011 and nearly 50% below their peak from five years ago.

WHAT CAN THE FED DO TO CALM THE REPO MARKET?

1. RUN SPOT REPO OPERATIONS

Through the Federal Reserve Bank of New York, the Fed can conduct occasional spot repo operations at times of funding stress, allowing banks and dealers to swap their Treasuries and other high-quality securities for cash at a minimal interest rate. It did this on Tuesday and will do it again on Wednesday.

2. LOWER THE INTEREST IT PAYS ON EXCESS RESERVES

By making it less profitable for banks, especially foreign ones, to leave their reserves at the Fed, it may encourage banks to lend to each other in money markets.

3. CREATE A STANDING REPO FACILITY

Such a permanent financing program will allow eligible participants to exchange their bonds for cash at a set interest rate.

Fed and its staff have considered such a facility, but they have not determined who qualifies, what would be the level of interest paid and the timing for a possible launch.

4. RAMP UP BUYING OF TREASURIES

The Fed can replenish the level of bank reserves by slightly increasing its holdings of U.S. government debt. This comes with the risk that it may be perceived as a resurrection of quantitative easing rather than a technical adjustment.

(Reporting by Richard Leong; Editing by Dan Burns and Richard Borsuk)

Trump ‘not ready’ for China trade deal, dismisses recession fears

FILE PHOTO: U.S. President Donald Trump meets with China's President Xi Jinping at the start of their bilateral meeting at the G20 leaders summit in Osaka, Japan, June 29, 2019. REUTERS/Kevin Lamarque/File Photo/File Photo

By Howard Schneider

WASHINGTON (Reuters) – U.S. President Donald Trump and top White House officials dismissed concerns that economic growth may be faltering, saying on Sunday they saw little risk of recession despite a volatile week on global bond markets, and insisting their trade war with China was doing no damage to the United States.

“We’re doing tremendously well, our consumers are rich, I gave a tremendous tax cut, and they’re loaded up with money,” Trump said on Sunday.

But he was less optimistic than his aides on striking a trade deal with China, saying that while he believed China was ready to come to an agreement, “I’m not ready to make a deal yet.”

He hinted that the White House would like to see Beijing resolve ongoing protests in Hong Kong first.

“I would like to see Hong Kong worked out in a very humanitarian fashion,” Trump said. “I think it would be very good for the trade deal.”

White House economic adviser Larry Kudlow said trade deputies from the two countries would speak within 10 days and “if those deputies’ meetings pan out… we are planning to have China come to the USA” to advance negotiations over ending a trade battle that has emerged as a potential risk to global economic growth.

Even with the talks stalled for now and the threat of greater tariffs and other trade restrictions hanging over the world economy, Kudlow said on “Fox News Sunday” the United States remained “in pretty good shape.”

“There is no recession in sight,” Kudlow said. “Consumers are working. Their wages are rising. They are spending and they are saving.”

Their comments follow a week in which concerns about a possible U.S. recession weighed on financial markets and seemed to put administration officials on edge about whether the economy would hold up through the 2020 presidential election campaign. Democrats on Sunday argued Trump’s trade policies were posing an acute, short-term risk.

U.S. stock markets tanked last week on recession fears with all three major U.S. indexes closing down about 3% on Wednesday, paring their losses by Friday due to expectations the European Central Bank might cut rates.

The U.S. Federal Reserve and 19 other central banks have already loosened monetary policy in what Fitch Ratings last week described as the largest shift since the 2009 recession.

Markets are expecting more cuts to come. For a brief time last week, bond investors demanded a higher interest rate on 2-year Treasury bonds than for 10-year Treasury bonds, a potential signal of lost faith in near-term economic growth.

White House trade adviser Peter Navarro on Sunday dismissed the idea that last week’s market volatility was a warning sign, saying “good” economic dynamics were encouraging investors to move money to the United States.

“We have the strongest economy in the world and money is coming here for our stock market. It’s also coming here to chase yield in our bond markets,” Navarro told ABC’s “This Week.”

For bond markets, the sort of movement Navarro described is often driven by trouble – in this case the possibility that the trade battle with China is lasting far longer than expected and becoming disruptive to business investment and growth.

The U.S. economy does continue to grow and add jobs each month. Retail sales in July jumped a stronger-than-expected 0.7%, the government reported last week, and Kudlow said that number showed that the main prop of the U.S. economy was intact.

But manufacturing growth has slowed and lagging business investment has become a drag.

A slowdown would be bad news for Trump, who is building his 2020 bid for a second term around the economy’s performance. He told voters at a rally last week they had “no choice” but to vote for him to preserve their jobs and investments.

The president and his advisers have repeatedly accused the Fed of undermining the administration’s economic policies. On Sunday, Kudlow again pointed the finger at the central bank, describing rate hikes through 2017 and 2018 as “very severe monetary restraint.”

The Fed hiked rates seven times over those two years as part of a plan to restore normal monetary policy following emergency steps taken to battle the 2007-2009 global financial crisis and recession.

Even with those steps, the Fed’s target interest rate has remained well below historic norms, and policymakers have started cutting rates in response to growing global risks.

Democratic presidential candidates on Sunday joined the many economic analysts who have said the administration’s sometimes erratic policies on trade – at one point threatening tariffs on Mexico over immigration issues – are to blame for increased uncertainty, disappointing business investment and market volatility.

“I’m afraid that this president is driving the global economy and our economy into recession,” Democratic candidate Beto O’Rourke said on NBC’s “Meet the Press.”

Speaking to CNN’s “State of the Union” on Sunday, Democratic candidate Pete Buttigieg criticized the administration for failing to deliver a deal with China.

“There is clearly no strategy for dealing with the trade war in a way that will lead to results for American farmers, or American consumers,” he said.

(Reporting by Howard Schneider; Additional reporting by Humeyra Pamuk and Ginger Gibson; editing by Michelle Price, Lisa Shumaker and Rosalba O’Brien)

Fed policymakers call for caution on further U.S. rate hikes

FILE PHOTO: A police officer keeps watch in front of the U.S. Federal Reserve building in Washington, DC, U.S. on October 12, 2016. REUTERS/Kevin Lamarque/File Photo

By Jonathan Spicer and Howard Schneider

RIVERWOODS, Ill./CHATTANOOGA, Tenn. (Reuters) – Another clutch of U.S. Federal Reserve policymakers said on Wednesday they would be cautious about raising interest rates without getting better a handle on how growing risks to an otherwise solid U.S. economic outlook could play out.

After months of tumult in the stock market, presidents of four of the 12 Fed regional banks said they wanted greater clarity on the state of the economy before extending the central bank’s rate hike campaign any further.

Three of the four, Charles Evans of Chicago, Eric Rosengren of Boston, and James Bullard of St. Louis, are voting members this year on the Federal Open Market Committee, the bank’s policy-setting panel.

Bullard has long been critical of the Fed’s rate increases, begun in December 2015, but the caution from Evans and Rosengren is new, even if they both believe growth will remain solid and rates will probably need to rise more.

The fourth president, Raphael Bostic of Atlanta, said there was no urgency to raise rates further at this juncture.

The remarks from the four come less than a week after Fed Chairman Jerome Powell eased market concerns that policy makers were ignoring signs of an economic slowdown. Powell said he was aware of the risks and would be patient and flexible in policy decisions this year.

Rosengren on Wednesday used those same two adjectives, while Evans said he would be “cautious.”

The new tone comes after the U.S. stock market dropped precipitously in the fourth quarter of 2018, suffering its worst December performance since the Great Depression. Other signs of tightening financial conditions surfaced as well, including a sharp slowdown in issuance of corporate bonds.

Short-term U.S. interest-rate futures are now pricing in less than a 2 percent chance of a rate hike this year, and traders see a one-in-four chance of a rate cut by next January.

That stands in stark contrast to forecasts from the Fed released after the central bank’s fourth 2018 rate hike in December. Those forecasts called for two more rate hikes this year.

Evans has been among the most vocal backers of gradually tightening U.S. monetary policy, and after a speech in Riverwoods, Illinois, on Wednesday told reporters he still believes the Fed will need to deliver three more rate hikes this year.

But, in his first public comments since November, he nodded to an array of “tough-to-read” factors highlighted by the recent market selloff, but penciled in a forecast for reasonably good U.S. growth and employment in 2019 and beyond.

Rosengren similarly said he expects solid growth this year and said he suspects financial markets are “unduly pessimistic.” But in a break from speeches last year, when he emphasized the risks of allowing unemployment to stay below sustainable levels for too long, Rosengren on Wednesday emphasized risks that could impinge on growth, and said he was taking on board the cautionary signals from falling stock markets.

“There should be no particular bias toward raising or lowering rates until the data more clearly indicate the path for domestic and international economic growth,” Rosengren told the Boston Economic Club. “I believe we can wait for greater clarity before adjusting policy.”

Bullard, meanwhile, told the Wall Street Journal that while the Fed had “a good level of the policy rate today,” there was no rush to push them higher.

Minutes from that meeting will be released later on Wednesday and could shed more light on how policy makers assessed the economy as they agreed to raise rates and, at that time, projected two more increases in 2019..

Overall, that marked the ninth increase of a quarter percentage point since December 2015, when the Fed began lifting interest rates from near zero, where they had been since the financial crisis in 2008.

Atlanta Fed President Raphael Bostic, who earlier this week said the Fed was likely to need at most a single rate increase this year, on Wednesday elaborated on that view as driven by conversations with business executives, who say they have become more defensive in preparing for slower growth by paying down debt and holding off on new plans.

Those conversations “are not consistent with the business sector ramping up,” Bostic said in remarks prepared for delivery to the Chattanooga Area Chamber of Commerce. Bostic, who backed all four rate hikes in 2018 as an FOMC voter, does not have a policy vote on the panel this year.

(Reporting by Howard Schneider in Chattanooga and Jonathan Spicer in Chicago; with reporting by Ann Saphir in San Francisco and Trevor Hunnicutt in New York; Writing by Dan Burns; Editing by Chizu Nomiyama)

Fed interest rate hike expected next week, three hikes expected in 2018/poll

The Federal Reserve headquarters in Washington September 16 2015. REUTERS/Kevin Lamarque/File Photo

By Shrutee Sarkar

BENGALURU (Reuters) – The U.S. Federal Reserve is almost certain to raise interest rates later this month, according to a Reuters poll of economists, a majority of whom now expect three more rate rises next year compared with two when surveyed just weeks ago.

The results, from a survey taken just before the U.S. Senate voted to pass tax cuts that are expected to add about $1.4 trillion to the national debt over the next decade, show economists were already becoming more convinced that rates will need to go even higher.

While about 80 percent of economists surveyed in October said such tax cuts were not necessary, the passage of the bill, President Donald Trump’s first major legislative success, means the forecast risks have shifted toward higher rates, and faster.

The poll’s newly raised expectations for three rate rises next year are now in line with the Fed’s own projections. But they come despite a split among U.S. policymakers on the outlook for inflation, which has remained persistently low.

That is a similar challenge faced by other major central banks, who are generally turning away from easy monetary policy put in place since the financial crisis, looking through still-weak wage inflation and overall price pressures for now.

The core personal consumption expenditures price index (PCE), which excludes food and energy and is the Fed’s preferred inflation measure, has undershot the central bank’s 2 percent target for nearly 5-1/2 years.

The latest Reuters poll results suggest it is expected to average below 2 percent until 2019.

While the U.S. economy expanded in the third quarter at a 3.3 percent annualized rate, its fastest pace in three years, the latest Reuters poll – taken mostly before the release of that data – suggested that may be the best growth rate at least until the second half of 2019.

The most optimistic growth forecast at any point over the next year or so was 3.7 percent, well below the post-financial crisis peak of 5.6 percent in the fourth quarter of 2009.

Still, all the 103 economists polled, including 19 large banks that deal directly with the Fed, said the federal funds rate will go up again in December by 25 basis points, to 1.25-1.50 percent.

“This is about just getting back to a neutral level where monetary policy is neither encouraging growth or pushing against growth,” said Brett Ryan, senior U.S. economist at Deutsche Bank, which recently shifted its view to four rate rises next year.

“The Fed is still accommodative at the moment and we are still some ways away from the neutral fed funds rate which would in the Fed’s view be closer to 2.75 percent. The Fed can hike without slowing the economy.”

Financial markets are also pricing in over a 90 percent chance of a 25 basis-point hike in December, largely based on the falling unemployment rate and reasonably strong economic growth this year.

Asked what is the primary driver behind the Fed’s wish to raise rates further, over 40 percent of respondents said it was to tap down future inflation.

However, almost a third of economists said it is to gather enough ammunition to combat the next recession.

“At some point we are going to have a downturn and they (the Fed) are going to need to react and it is harder to do that when rates are closer to zero,” said Sam Bullard, an economist at Wells Fargo.

The remaining roughly 30 percent had varied responses, including some who said higher rates were needed to avoid risks to financial stability.

Over 90 percent of the 66 economists who answered another question said that the coming changes at the Fed – a new Fed Chair along with several new Fed Board members – will also not alter the current expected course of rate hikes.

“Both the rate tightening outlook and balance sheet reduction program will remain in place as the Fed officials fill open seats. Easing of financial regulation is likely the area that has the most forthcoming changes,” Bullard said.

 

(Additional reporting and polling by Khushboo Mittal and Mumal Rathore; Editing by Ross Finley and Hugh Lawson)