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FOMC preview: more to come from the Fed

The Fed’s focus at this week’s meeting will be on hammering home the message that it will do ‘whatever it takes’.

Fed Source: Bloomberg

The Federal Reserve (Fed) is not out of ammunition. That was the case at the beginning of the year, but many doubted it. However, the past two months have shown that the world’s most powerful central bank is not afraid to use any and all means at its disposal to prop up the US economy.

In this task, it is aided by the economic data. The advance reading for US first quarter (Q1) is released on Wednesday, ahead of the Fed decision and press conference.

FOMC meeting to show sharp deterioration in US economic picture

It is expected to show a sharp deterioration in the US economic picture, with forecasts suggesting a drop of 4%, the first contraction since Q2 2014. But it is likely to get much worse – Q2 will see the full impact of the shutdown on the US economy, leading to a much sharper economic downturn, pushing the US into recession for the first time since 2009.

Unemployment is also a worrying sign. Adding together the jobless numbers in the US over the past few weeks suggests that around 26 million Americans have lost their jobs since the crisis began. While the trend is getting better, we can still expect millions more to lose their jobs.

Much of what happens next will depend on the recovery and its shape. This has been much-debated, with 'V', 'L' or 'U-shaped' recoveries mooted as a possible exit path. It is fruitless to predict what the shape will be, but the duration of the economic contraction and the time it takes to return to ‘normality’ will be the main drivers of the Fed’s policy.

Markets should take note of what future measures Fed might take

While we don’t expect any big policy moves at this week’s meeting, the Fed will do what the European Central Bank (ECB) is also expected to do at its meeting this week, namely pledge to do more if necessary. Its actions have already extended to buying junk bonds, with others calling for it to buy equities. But it still has the space to use existing facilities, having only deployed around $195 billon of the $454 billion for the emergency backstop. Even if this is used up, we can expect other measures, all of which are designed to provide liquidity and cushion the economic shock.

Therefore, markets should not be too quick to expect fresh measures this time around, but should take careful note of the Fed’s commitment to do what is needed. Investors who underestimated the Fed’s power and resolve were caught out by the size of the policy packages passed, but should not make a similar mistake and assume that the Fed is out of bullets.

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