- FOMC expected to stress that it will do whatever its takes but no new easing moves are expected
- U.S. GDP begins its descent
- China’s April PMIs are expected to stay above 50
FOMC expected to stress that it will do whatever its takes but no new easing moves are expected — The FOMC at its 2-day meeting that ends today is likely to stress that it has already thrown everything it can at the pandemic crisis and that it is now time to wait to see if it works. The Fed has already adopted the most stimulative monetary policy in its history by slashing interest rates to nearly zero and adopting an unlimited QE program.
The Fed has increased its balance sheet by $2.4 trillion (+58%) to a record $6.57 trillion just since the end of February, which is a much larger increase than the $1.7 trillion QE3 program in 2012-14 that took two years to complete. The Fed has also adopted a variety of emergency programs that are providing liquidity to key markets and entities.
The markets are not expecting the Fed to cut the funds rate any farther because it is already essentially at zero. Fed Chair Powell in the past has thrown cold water on the idea of negative interest rates in the United States, regardless of the circumstances, since the Fed is not convinced they have been effective in Japan and Europe. Negative interest rates are a double-edged sword because they represent an easier monetary policy but hurt bank profitability and individual savers.
The markets are currently expecting the Fed to leave its funds rate target at the current level of 0.00%/0.25% for at least the next two years. Even in three years (i.e., by March 2023), the market is discounting only about a one-third chance of a +25 bp rate hike, according to the longest-dated federal funds futures contract that is currently trading.
There is an outside chance that the Fed today might raise its IOER (interest on excess reserves) rate from the current level of 0.10% because the funds rate in the past several weeks has been trading at 0.04%, well below the 0.125% mid-point of the funds rate target range of 0.00%/0.25%. The Fed might want to raise the IOER to push the effective funds rate up towards the target mid-point.
However, the Fed will probably be reluctant to make that move today since it could be interpreted by some as a tighter monetary policy. That would be contrary to the Fed’s message right now, which is that it will do virtually anything within its statutory authority to prevent the pandemic from causing a financial crisis or a downward-spiraling depression.
U.S. GDP begins its descent — The consensus is for today’s Q1 GDP to show a decline of -3.9% (q/q annualized), thus ending the longest U.S. economic expansion in post-war history and marking the beginning of a deep recession.
Today’s Q1 GDP report will not be nearly as important as the Q2 report, which will see the worst of the economic damage. There were stay-at-home orders and shutdowns of non-essential businesses in much of the U.S. from late March through April. Some areas are expected to begin to reopen on a limited basis in May and June, but there will still be major economic damage throughout the second quarter and likely into the third quarter.
The current consensus is for U.S. GDP in Q2 to plunge by -26.0% (q/q annualized), which is equivalent to a -7.3% quarter-on-quarter decline (as a side note, negative annualized figures look much different than positive annualized figures). That would produce a peak-to-trough decline in the first half of 2020 of -8.3% (adding together the -1.0% q/q drop in Q1 and the -7.3% q/q drop in Q2).
The consensus of an -8.3% peak-to-trough drop in GDP in the first half of 2020 would be more than double the -4.0% peak-to-trough drop in GDP during the Great Recession (2007-09). However, it would be less than the common definition of a depression of at least a -10% drop and far less than the Great Depression’s drop of -26%.
The consensus is for U.S. GDP to partially recover in the second half of the year with increases of +9.0% (q/q annualized) in Q3 and +6.4% in Q4. On a calendar year basis, the consensus is for GDP growth in 2020 to fall by -3.7% and then recover by +3.8% in 2021. However, the current optimistic forecasts for 2H2020 are based on hopes that the U.S. economy will reopen quickly and fully, and there will be no pandemic relapses that require renewed shutdowns later this year. The CBO is much less optimistic than the consensus and is forecasting a -12% q/q plunge just in Q2 GDP (-40% annualized).
For reference, China’s GDP in Q1 showed a very steep decline of -9.8% q/q (-6.8% y/y), which perhaps by no coincidence was just shy of the -10% definition of a depression. The good news for China is that the consensus is that its GDP drop was limited to Q1 and that GDP in Q2 will recover by +8.2%. However, that may be too optimistic since China is only at about 95% of economic capacity and since China is taking a hit in Q2 from the fact that much of the rest of the world is currently shut down.
China’s April PMIs are expected to stay above 50 — The consensus is for today’s China Apr manufacturing PMI to show a -1.0 point decline to 51.0, giving back a little of March’s +16.3 surge to 52.0. The consensus is for today’s April non-manufacturing PMI to show a +0.2 point increase to 52.5, adding to March’s +22.7 point surge to 52.3. Before March’s recovery, China’s PMIs in February bottomed out at record lows of 35.7 for the manufacturing PMI and 29.6 for the non-manufacturing PMI. The upward rebound in China’s PMIs above 50 in March only showed business confidence relative to the debacle in February and does not represent any major optimism among Chinese business people, particularly since most of the rest of the world is currently shut down and is not buying much from China.
