Fed Has No Plans of Backing Off Support Anytime Soon

Federal Reserve

Some were afraid that the recovery that will come when COVID goes away would cause the Federal Reserve to back up their mega support of the economy. Not anytime soon.

It wasn’t that long ago when the big potential issue with the Federal Reserve during its Federal Open Market Committee meetings was its changing its interest rates, or failing to do so if a change may be expected. My, have times changed.

It is not that the stock market no longer cares about interest rates, and it still cares very deeply about the issue, it’s just that interest rates have been taken so far out of the conversation now. The Fed wasted no time putting the benchmark overnight rate that so many people pay so much attention to earlier in the year, and have long since told us that there are no plans at all right now to even consider putting rates up.

We would not only need a recovery to get the Fed to change direction, we would have to see inflation running pretty hot, hotter than the usual 2% target that they use as the ideal. We saw them jack up the rate quite a bit in 2018, at a time where we were running over 3% for a time, but today’s reality is far different.

Even after the amount that the economy has come back once the worst of the lockdowns were over and a lot more people went back to work, and a lot more shops opened, the economy remains semi-choked. The restrictions have really picked up lately, and this risks giving some of the gains back that we achieved since the widespread lockdowns ended, if you can even call getting part of what you lost back an achievement.

The only way to get back to where we were to start this year would be for this whole mess to disappear, because if we are even just socially distancing, this limits business activity. If business activity is more limited than it was a year ago, this will represent an economic handicap that cannot be so quickly offset by growth in less affected or unaffected sectors.

The belief that this will take quite a while to recover from has been pretty widely known for a while now, and the Fed actually took the lead in telling us this, based upon their data. The Fed does tend to have the best data, as the country’s economic fate depends upon this, and it is also in their interests to do the best research because their success depends on it.

With the focus now completely off interest rates, people now look to the Fed to see what their plans are for continuing on with the massive quantitative easing that they have been doing lately, as well as their buying securities other than treasuries, to directly support these markets.

In Wednesday’s session of the FOMC, the Fed assured us that their commitment to continuing to support the economy and markets has not waned, and the plan is to continue this well into 2021. We haven’t reached the promised land or anything even close yet, so it would not make any sense at all for them to ease up right now anyway.

No Change at the Fed Now Means No Easing Up on the Gas

The vault will therefore remain open for quite a while, based upon forecasts, and they have some good forecasts. It is not that the Fed hasn’t made it clear that they are willing to tolerate higher inflation numbers during the recovery, although they haven’t explained all that well why this is actually necessary.

We can use a simple example to show this better. Let’s say the economy grew by 2% in year one, then went to 0% growth in year two. If we simply let it go back up to 2%, then we will not regain any of what has been lost in year two. We actually need to make up 2% here, like what having 3% growth for both year three and four would do. At this point we would be back to the average growth of 2% per year across all four years, as if year two did not happen.

Inflation works in a similar way, and we can simply substitute the word growth with the word inflation, and this would be applicable in the same way and for the same reasons. Some may think that since inflation is bad, a measure of damage of a sort, a loss of value, we need a little of this going on to keep moving forward and not seeing the economy stagnate.

When we invest, for instance, we are investing in growth basically, our expectations of growth in the future being traded among us in the present, which is what stocks represent. If we set growth and inflation to zero, the future value of these investments and their present value would be the same, and this would turn stocks into a form more like currencies, where you park your money just to park it.

You just can’t have growth without inflation, as growth increases the money supply and that in itself devalues it. Inflation is really just a measure of how much was lost from year to year in real money, and growth puts prices up and this in turn makes the same amount of money worth less than last year, at the inflation rate.

This all has the Fed willing to keep the ship going full steam ahead for a longer period than normal, where they see the need for inflation to run hotter than they usually like for a time to catch up. There’s a reason behind the Fed preferring 2% inflation, not just 1% for instance, and prefer this 2% over the long term. When we lose ground like we have, the goal should be to recapture what was lost in terms of growth, and this will also see inflation needing to be higher over this time as well.

Vaccines Won’t Derail the Fed’s Exuberance at All

Now that these new vaccines are being rolled out, some have seen this as being likely to produce a recovery rate in excess of the Fed’s projections and perhaps cause the Fed to back off sooner than they have been suggesting. The thinking here is that if we get back to full production or close to it from the wonders of these vaccines taking away people’s reluctance to congregate, or the state’s reluctance toward it, we’ll be back to normal in a flash.

There still are some thinking this, in spite of the Fed telling us now long the road back will be as late as yesterday, where they have the same information about what is going on now as anyone. They hear the hope out there, and also hear from public health officials that the plan is not to take their foot off the brakes even with widespread vaccination.

There is a good reason for this as it turns out, if you think that these restrictions don’t make things worse than better, if you have ignored both the science and the data, which public officials continue to do. They get to decide, although if vaccination really did stop transmission of this virus, it would be at least much harder to justify these restrictions.

It turns out though that these vaccines have already been ruled out in stopping transmission, and this actually failed in the animal trials. Lockdowns and restrictions are completely about transmission, as this is what they seek to do. As it turns out, this is like trying to hide from the air, which is the mechanism of transmission, and nothing that has been proposed has the power to stop air from flowing around.

Whatever ends transmission of this virus, and there’s only one thing that can and that’s when the virus sees its previously uninfected population wane as it infects more and more, and eventually runs out of fuel, it will not be these vaccines. This is why we are being told that they aren’t even planning any changes after the vaccination program gets rolled out as far as restrictions go.

This evidence therefore falls in the favor of the Fed’s less optimistic view than those who think that these vaccines are going to fix everything. This does not mean that the Fed is right about this though, as natural infection does slow down transmission, because as more and more people get infected, there are more and more people that have gotten over it and are not at risk of any further transmission.

This is what it will come down to, and the idea that this could go on for as long as some people think just doesn’t square with reality. We do need to be aware of this as we look to try to predict the trajectory of our economic recovery, and while the end of COVID has been just a guess so far, we can be sure that it will run out of fuel sooner rather than later.

The love that the Fed has given markets won’t stop as long as it is needed and then for some time after that as we make up lost ground. This will be well telegraphed as economies do not move all that fast. When the time does come, we’ll have seen inflation run too hot for a while, until the Fed has had enough, and will give us plenty of warning as well.

Wednesday’s call by the Fed was still music to the market’s ears, as the Nasdaq hit another record high, finally besting its early September peak. In spite of everything else that has happened, nothing affects markets quite like the Fed, and the big hug will continue.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: [email protected]

Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.