HIGHLIGHTS OF THE WEEK
- Equity markets digested the possibility of a long and arduous economic recovery by pulling back this week. At the time of writing, the S&P 500 was down 4% from its close last Friday.
- The Fed’s updated economic projections played a role in the decline. Fed members expected the economy to contract by 6.5% and the unemployment rate to hit 9.5% in 2020.
- Given the weak outlook, the Fed expects to keep interest rates near-zero through 2022. Monetary policy alone may not be enough to support the economy. The sooner Congress acts, the better.
Fed Projection Injects Markets With A Dose of Reality
It was another eventful week in financial markets, as equity investors digested the very real possibility that the road to recovery could be long and arduous. Dire economic outlooks released by the World Bank, OECD, and Federal Reserve shocked investor sentiment, leading to a sharp sell-off in equity markets on Thursday. At the time of writing, the S&P500 was down 4% from close last Friday.
The Federal Open Market Committee’s (FOMC) view on the U.S. economy was certainly a factor driving the decline in markets. Along with the decision to leave the target range for the federal funds rate unchanged at 0% to 0.25%, the FOMC also released the Summary of Economic Projections (SEP), which captured the worries of participants. The median forecast for real GDP in 2020 was a decline of 6.5% (fourth quarter to fourth quarter), before rebounding by 5% in 2021 (Chart 1). The median unemployment rate was projected to be 9.5% by the end of 2020, and only improving to 6.5% next year. The long-term view on the unemployment rate was unchanged at 4.1% implying that participants did not expect the pandemic to lead to higher structural unemployment over the long run.
In terms of inflation, FOMC members expected the headline personal consumption expenditures (PCE) deflator to increase by just 0.8% in 2020 and 1.6% in 2021. The outlook for the core PCE measure was not much different. This is in line with the weak reading we have been receiving from price variables recently.
After falling by 0.8% month-on-month in April, the consumer price index (CPI) fell by 0.1% month-on-month in May (Chart 2). Energy prices posed the greatest drag on headline prices, declining by 1.8% on the month. Food prices, on the other hand, rose by 0.7% reflecting the havoc COVID-19 was having on production facilities. Excluding food and energy, prices still declined by 0.1% in May, the first time core CPI fell for three consecutive months.
As we had written in a recent report, even with states opening up their economies, inflation will likely remain weak in the near-term. Over the long run, the outlook is more uncertain. Weak demand could keep inflation at low levels but continued extraordinary policy support could lead to more rapid price growth.
Indeed, the Fed plans on providing monetary aid for at least the next couple of years. As indicated by the SEP, the federal funds rate is expected to remain near zero through 2022. But monetary policy alone cannot hold up the economy during this crisis. More fiscal support is likely to be needed once unemployment benefits provided by the CARES Act expire at the end of July. Congress has taken up the issue and Treasury Secretary Mnuchin has backed the idea. The sooner Congress acts, the better for the economy.
Sri Thanabalasingam, Senior Economist | 416-413-3117
This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. This report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise the TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.