The Federal Reserve’s first foray to the zero lower bound lasted from 2008 until 2015. Now again, the unprecedented shutdown of the U.S. economy to try to slow the spread of the coronavirus led the Fed to cut rates to near zero in mid-March.
While no one knows how long the virus will keep the economy shut down, analysts expect the Fed will have to keep rates at ZLB for the foreseeable future.
“The Fed has taken its policy rate to the lower bound, has said it will be there for some time, and tied liftoff to longer-term developments in inflation,” Morgan Stanley Research noted. “Our inflation forecast suggests that even by end-2021 it will be too early for talks on when it is appropriate to lift rates.”
“I expect the Fed to use forward guidance to pin front-end rates at the zero lower bound for the next three to five years,” said Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle Investments. “So look for the two- to five-year segment of the curve to be around 25 basis points with volatility suppressed by the Fed’s balance sheet going forward.”
“A risk to this view is that there is a change in the underlying inflation dynamics or productivity growth coming out of the recession and the Fed is forced to react to inflation expectations anchoring above 2%,” he added. “The odds of this are remote, in my mind.”
“The Federal Reserve will keep interest rates at near zero rates until the U.S. economy has returned to its pre-crisis growth path, which we estimate to be about two years,” said Steve Skancke, chief economic advisor at Keel Point. “While we expect a sharp rebound once the COVID-19 containment measures are lifted, not all economic activity will return immediately.”
While some jobs (and consumption) won’t be recovered, “a best case for the U.S. economy is a two-year timetable to get back to 2.6% annualized growth rate, even with impressive annualized rebound growth numbers likely in the fourth quarter of 2020,” he said.
GDP will need to hit a 2.6% annualized growth path before the Fed will raise rates. It will also “avoid any actions that would interrupt the recovery. With few stimulus measures left in its arsenal, the Fed can’t risk moving too soon to reverse them,” Skancke said.
“The Fed won't be able to raise rates until a full recovery is in clear sight and heightened risk aversion has subsided,” said Peter Ireland, an economics professor at Boston College and a member of the Shadow Open Market Committee.
Such a recovery would happen no earlier than late this year. “We could see zero rates persisting into 2021 if the shutdown drags on and the recovery is more gradual,” Ireland said. “But I am still optimistic that all this will be behind us by December.”
The “Fed's massive interventions have finally restored some order to the markets,” and “worst-case scenarios,” seem “much less likely now than they did a week and a half ago,” he said.
And although the shutdown was extended through April, he predicted, “The economy will bounce back quickly in late spring and summer, but it is unrealistic to think that everything will immediately get back to normal. And that includes Fed policy.”
“The Fed is going to keep rates at zero for a while, certainly until at least to the end of 2020 and perhaps all the way to the end of next year,” said Rob Robis, Chief Global Fixed Income Strategist at BCA Research.
“The highly indebted U.S. economy needs more inflation to help reduce the debt burden, especially in the private sector (i.e., corporate debt),” he said. “The Fed will do everything it can to ensure that outcome by staying very dovish for much longer.”
KBW analysts expect “recession in 2020 followed by a period of slow growth, low rates, and high unemployment as the U.S. economy struggles to reengage post recession.”
Projection gross domestic product will fall 2.0% in the first quarter, 18% in the second and 5% in the third before a slightly positive (0.3%) number in the last quarter of 2020. “While the fiscal and monetary policies put in place are a clear positive, the economic impact of a global shutdown will take several quarters to work through the economy,” KBW said in a report.
The firm expects “the Fed to remain range bound at this range for an extended period of time.”
When containment measures start reducing the daily infection rate, “markets can begin to anticipate a reduction in ‘seismic’ economic data releases," said Colin Moore, global chief investment officer at Columbia Threadneedle Investments.
“The duration and intensity of a recession depends on the duration of the shutdown and whether there is an adequate policy response from monetary and fiscal authorities to help cushion the blow,” added Anwiti Bahuguna, the firm’s head of multi-asset strategy. “Early signs are encouraging.”
Hank Smith, Co-CIO at The Haverford Trust Company expects the worst to be over in the fall. “The economic hit will be seen in the second quarter and first half of the third quarter,” he said. “Then, there will be an unleashing of pent-up demand as consumers resume their normal lives, aided by monetary and fiscal stimulus.”
Ron Carson, founder and CEO of Carson Group, sees the Fed staying at ZLB for at least a year to 18 months.
Data
Pending home sales gained 2.4% in February, and rose 9.4% year-over-year, the National Association of Realtors said Monday.
Economists polled by IFR Markets expected a 1.0% decline.
“February’s pending sales figures show the housing market had been very healthy prior to the coronavirus-induced shutdown,” said Lawrence Yun, NAR chief economist. While February’s numbers do not include the period when the shutdown began, he was “optimistic that the upcoming stimulus package will lessen the economic damage and we may get a V-shaped robust recovery later in the year.”
Separately, the Texas Manufacturing Outlook Survey contracted in March.
“The headline production index declined more than 50 points — an unprecedented drop — to its second-lowest reading ever recorded since the survey began in June 2004,” said Emily Kerr, Federal Reserve Bank of Dallas senior business economist. “The March reading of negative 35 was surpassed only during the Great Recession.”
Other readings that dropped to lows not seen since the Great Recession included the company outlook index, which hit an all-time low of negative 66.
“The COVID-19 pandemic was certainly the main driver of declines in the sector, according to commentary from the manufacturing executives,” Kerr said, “though some also note the collapse in oil prices."
