The economy has taken a hit from weaker demand and shutdowns, and the second quarter is expected to be worse.
In an April 29 press conference, Fed Chair Jerome Powell noted that the Fed will be “very patient” and is not in a hurry to move the rate up.
In a statement, the rate-setting Federal Open Market Committee said, “The coronavirus outbreak is causing tremendous human and economic hardship across the United States and around the world,” noting that impact from the measures to protect public health “are inducing sharp declines in economic activity and a surge in job losses.”
The Fed also expects that the “ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
Q1 economic output contracts; Q2 will be worsePowell said the risks the FOMC is referring to include unknowns such as how long it will take to get the virus under control, whether there will be any additional outbreaks of COVID-19 and when there will be drugs available to treat the disease.
Economists anticipate that the shutdown of the U.S. economy has pushed it into a nasty recession, which typically means at least two consecutive quarters of decline in economic output.
The government reported on April 29 that first quarter U.S. gross domestic product slumped at an annualized rate of 4.8%, compared to GDP growth of 2.1% in the fourth quarter of 2019. The large-scale unemployment that has resulted from the shutdown has also impacted consumer demand. Consumer spending, which accounts for about 70% of U.S. GDP, declined 7.6% in the first quarter.
Considering that the shutdowns largely began in March, the damage is expected to hit harder in the second quarter.
“We’re going to see economic data for the second quarter worse than any we’ve seen,” Powell said.
According to Wells Fargo Securities’ U.S. economy outlook for April, most of the decline in economic output will be in the second quarter, with inflation-adjusted economic output falling at an annualized rate of 22%.
The firm also expects there will be job losses of more than 20 million before this recession bottoms, pushing the unemployment rate to north of 15%. Wells Fargo anticipates a recovery to begin in the summer, with economic output jumping at an annualized 7.2% rate in the third quarter, with the caveat, “of course, much depends on the progression of the virus.”
Ryan Sweet, a Moody’s Analytics economist, anticipates a “W-shaped” recession and recovery.
“That means the deep slide in the economy that we are suffering now, a bounce when businesses begin to reopen and then a modest slump as consumers and businesses remain cautious until a vaccine becomes available and the economy fully engages,” Sweet said. “Under any shape, the recovery will take time.”
And according to TD Economics, in an online commentary, “The level of real GDP is anticipated to remain below its pre-virus level until 2022. As it has in past downturns, lingering uncertainty is anticipated to weigh on investment even once a recovery in household spending takes place.”
Fed will anchor inflation expectations to avoid deflation
Another fallout from weak demand, and weaker oil prices, is the possibility of disinflation. Wells Fargo anticipates that consumer spending will ramp down 28% in the second quarter. Businesses are also not in a hurry to invest, and oil prices have taken a hit with reduced interest in air travel and as people drive less.
Based on the experiences of countries such as China and South Korea, which have been fighting COVID-19 for a while, Moody’s anticipates that the U.S. will see a “noticeable deceleration in the core Consumer Price Index” this year.
However, Sweet said, “We don’t anticipate the economy falling into a deflationary trap. Deflation is a persistent decline in core inflation. Deflation is economically debilitating as it feeds on itself.”
Powell said the Fed will ward off the threat of deflation by “anchoring inflation expectations” to the Fed’s 2% target. Even if very low energy prices take the headline inflation lower, he expects the core inflation rate – which excludes volatile food and energy prices – to be more indicative.
Are negative interest rates a possibility?
The Fed will continue to monitor the situation and “use its tools and act as appropriate to support the economy.” The minutes from FOMC’s March 15 meeting reveal that Fed officials would prefer to opt for other measures than taking its target interest rate negative in case further accommodation is required.
Additional measures could include “forward guidance,” whereby they would communicate to the public what they expect the future course of monetary policy to be, or balance sheet measures of buying and selling assets.
However, given that the near-term outlook continues to be uncertain, and other countries such as Japan, Sweden and Denmark have gone this route in the past, the possibility of negative interest rates lingers. Indeed, Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis, recently suggested that the Fed should take its rates negative.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, noted in his April 28 daily email commentary that he doesn’t expect the Fed to go this route.
“The immediate issue – which will persist, at least, in part for months as lockdowns are gradually eased – is people’s lack of opportunities to spend, rather than the lack of wherewithal,” Shepherdson wrote. “Slightly cheaper credit doesn’t make any difference if stores are closed.”
Also, people and businesses could see negative interest rates as “evidence of panic at the Fed,” which would impact their spending even after the lockdowns are over.
Moody’s doesn’t see the possibility of the Fed taking its target rate negative either.
“A number of other central banks are using negative interest rates, but we have been of the view that it is not likely to be a last-resort tool for the Fed,” Sweet said. “The effectiveness of negative interest rates used by other central banks has been mixed.”
See related: How I’m spending differently during the pandemic
Will cardholders benefit from negative interest rates?
Even in the unlikely event the interest rates that credit card rates are based on turn negative, it doesn’t seem cardholders will see much benefit from that.
According to Ted Rossman, industry analyst at CreditCards.com, even if the average credit card rate dropped a percentage point to about 15%, the minimum payment on the average $5,700 balance would drop by about $5 a month.
“The bigger deal for consumers would be that a low – or lower – rate environment could lead to higher fees in other areas. Banks are definitely hurting between lower rates, lower spending and the prospect of higher delinquencies and defaults,” Rossman noted.