Five things to watch at the Federal Reserve meeting

The Federal Open Market Committee meets on Wednesday for the last time before the US presidential election — and the first time since it embraced a new monetary strategy that will be more tolerant of higher inflation and more committed to promoting full employment.

The US economy is still grappling with the shock of the Covid-19 pandemic, and with less fiscal support on the horizon, Jay Powell, the Federal Reserve chairman, and other officials will have to weigh what additional support they can offer for the recovery.

Here are five things to watch:

A rosier forecast, with caveats

Fed officials are expected to produce a rosier set of economic projections for this year than they did in June.

The unemployment rate has already fallen to 8.4 per cent, well below the Fed’s median forecast of year-end joblessness of 9.3 per cent — so the question will be how low it is expected to go by December.

Meanwhile, output is expected to shrink by less than the 6.5 per cent this year predicted by US central bankers three months ago.

The improvements reflect a better than expected performance for the economy as it dealt with surges in infection over the summer. But the long-term projections may attract more attention, as they will stretch to the end of 2023. 

Will Fed officials expect US interest rates to remain at zero until then, especially given their ultra-dovish strategy shift announced last month, which allows them to let inflation run higher than the 2 per cent target before they tighten policy? And will their inflation forecasts show any overshooting? 

The Fed’s view is still that the US faces a long and challenging recovery and there are big risks on the horizon. The path of coronavirus over the autumn and winter, as it intersects with the seasonal flu, is unclear; new fiscal support for the economy is very much in question; and the looming US election could be destabilising if it delivers an uncertain result. 

Sounding the fiscal alarm

Mr Powell — and other Fed officials — have been clear that they would like Congress and the White House to agree on a new relief package to sustain the rebound. But having been ignored so far by the Trump administration and lawmakers on Capitol Hill, how hard will the Fed chairman go in haranguing them for their failure to act? 

The Fed is worried that the lack of a fiscal agreement will threaten the recovery and make its job harder. The US central bank does not want to be left alone in propping up the recovery. 

The Fed also has acknowledged it lacks the tools to solve all the problems in the economy, since it can only lend money, but not spend it to help businesses or households. And the Fed is acutely aware that its policies have done plenty to save financial markets from distress, but cannot deliver benefits as easily to low-income families and the unemployed.

New guidance for a new era

After the Fed made its historic announcement last month that it would tolerate higher inflation, investors wondered how such a policy would work in practice. Fed officials past and present have since lent their support to the new monetary framework, but there have been few specifics about what action is to be taken, and when. 

One potential tool that has garnered attention from both market participants and FOMC members is a more explicit form of forward guidance. This would involve the Fed tying interest rate adjustments to specific economic metrics such as the unemployment rate or inflation. 

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