Preview of the Fed meeting: 4 key questions puzzling Fed as new coronavirus risks loom

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It’s a new year for policymaking at the Federal Reserve, but officials are kicking off their January meeting with many of the same goals as before — and the same worries.

The hope is that the economy will come roaring back to life later this year, thanks to vaccines and more fiscal stimulus under President Joe Biden’s new administration. That would be welcome news for the rate-setting Federal Open Market Committee (FOMC) as it seeks to restore the bustling labor market backdrop that prevailed before the pandemic, perhaps paving the way for higher inflation.

But the rebound is sputtering, with joblessness on the rise again and the virus still spreading, keeping some consumers locked down in fear of infection. All of that means officials’ work is going to be cut out for them: Interest rates should remain at zero for as far as the eyes can see.

“We are literally on a bridge over troubled waters right now,” says Greg McBride, CFA, Bankrate chief financial analyst. “The Fed is more worried about the economic recovery stalling out than they are about the economy overheating.”

Here’s four topics to keep an eye on ahead of the Fed’s January meeting, including what it means for your wallet.

1. As the economy faces a critical juncture, how will the Fed change its tune?

The U.S. economic backdrop hasn’t changed all that much since officials last gathered in December. But what matters most is that it hasn’t gotten better — and data all but confirms the Fed’s suspicions that the labor market is weakening.

Officials at their December meeting fretted over a resurgence in virus cases, according to records of their last gathering. Even back then, they noted that the expansion would slow in the coming months.

Then, weeks later, the Labor Department published its last jobs report for 2020, which showed that employers cut some 140,000 jobs in the month, marking the first decline since the recovery began in May. Meanwhile, close to 2 million Americans have submitted new applications for unemployment benefits over the past two weeks, the fastest pace since March.

Yet, far fewer states are shut down at this point in the coronavirus pandemic as compared to the initial wave back in March, highlighting a conundrum beleaguering Fed officials: It’s the virus that’s predominantly holding the labor market back, not restrictions. And with that admission comes a challenging reality that the rebound cannot be robust if the virus is still running rampant. A slower-than-expected vaccine rollout suffering from delivery and production bottlenecks will also only kick that snapback farther down the road.

“The big concern right now is the labor market,” says Steve Rick, director and chief economist at CUNA Mutual Group. “Government-mandated shutdowns are taking a hit in many parts of the country like California, but people are staying at home and not wanting to venture out even if they could. We’re in the worst of it right now.”

Officials in their post-meeting statement are bound to reaffirm the continued economic toll of the pandemic, stressing that the Fed remains committed to employing its “full range of tools” to fight the economic damage.

2. Rising 10-year Treasury yield: Will it prompt Fed intervention?

Fed watchers will likely be waiting for the central bank to address a recent uptick in the 10-year Treasury yield, which influences mortgage rates.

The rate on 10-year notes issued by the U.S. government topped 1 percent on Jan. 6 for the first time since March, soaring to as high as 1.15 percent nearly a week later. The yield has slowly crept downward, stabilizing at 1.10 percent as of Jan. 20. Experts say that shift could eventually push mortgage rates higher.

That would make the Fed’s job harder if it goes on long enough, first because it pushes interest rates higher than where the Fed wants them to be, and second because it could tap the brakes on the economy even more.

Historically low mortgage rates have helped ignite a housing market boom, one of the few remaining bright spots in a pandemic-ravaged economy. That activity has in turn helped buoy banks’ bottom lines and the broader economy itself, as consumers race to lock in lower rates and shave hundreds of dollars off of their monthly payments.

Some experts wonder whether the uptick could shake up the Fed’s asset purchases. The Fed is currently buying at least $120 billion of Treasury and mortgage-backed securities a month, but that’s mainly for financial stability concerns. To stimulate growth more and keep a lid on rates, the Fed could instead choose to shift the composition of those purchases and buy longer-dated assets. That’s an unconventional monetary policy tool more formally called “quantitative easing,” which is also one of the few substantive tools the Fed has left to help give the economy a boost.

But the Fed may still want to hold that last-ditch measure close to the vest, employing it at a time of optimal effectiveness and when the economy truly needs the help.

“We’d have to see interest rates move on the 10-year Treasury still quite a bit from here before the Fed became concerned about taking action,” says Yung-Yu Ma, chief investment strategist at BMO Wealth Management.

3. The great inflation debate: What will it mean for the Fed?

Rates on the 10-year Treasury tend to rise in spurts, both up and down, according to McBride. They’ve also risen as of late because investors are expecting more government stimulus, a faster economic recovery and, eventually, higher inflation.

“But we’ve got to get there first,” he says. ”It’s not something to lose any sleep over at this point.”

It highlights a growing sentiment that a vaccine rollout, accompanied by elevated household savings levels and pent-up demand, could unleash more price pressures later on in the year.

One such example of an inflationary channel could be the travel industry, McBride says. When vaccinations reach mass scale, “That could lead to a big surge in travel demand that outpaces capacity for a while. People want to get on airplanes a lot faster than the airlines can get their crews retrained and airplanes out of storage, through all their maintenance checks and back on the line. That leads to higher airfares.”

But the trick for the Fed will be judging what’s temporary versus sustained. Data may also be murky throughout most of 2021. Meanwhile, a rebound robust enough to prompt higher inflation might be the Fed’s best-case scenario, after price pressures remained stubbornly below the Fed’s 2 percent target for years. It’s also unlikely to steer the Fed away from its lower-for-longer course.

“The Fed has probably switched its focus more toward the full employment or maximum employment mandate and getting the economy moving again,” Ma says. “There is even a focus more than in the past on equity, the idea that the economy running a bit hotter tends to disproportionately benefit some of the more disadvantaged groups. That’s a relatively new focus for the Fed that also points toward it allowing the economy to run a little bit hotter.”

4. New sheriffs in town: President Joe Biden and rotating FOMC committee members

Two key differences between now and 2020 is that there’s a new president in the Oval Office and new voting officials on the FOMC.

President Joe Biden was inaugurated as the 46th U.S. president on Jan. 20.

Meanwhile, the Fed’s annual game of musical chairs with its regional reserve bank presidents means the Atlanta Fed’s Raphael Bostic, Chicago Fed’s Charles Evans, Richmond Fed’s Thomas Barkin and San Francisco Fed’s Mary Daly will have a vote on interest rate decisions this year. Meanwhile, the presidents of the Minneapolis, Philadelphia, Dallas and Cleveland Fed banks will be rotating off for the next 12 months. All officials, however, attend and contribute to discussions at FOMC meetings.

Trump-appointed Fed governor Christopher Waller, who cleared his Senate confirmation in mid-December, will also join the table for his first official rate-setting meeting.

Neither shifts are bound to change the picture all that much, though Biden’s plans to go big on fiscal stimulus with a $1.9 trillion economic rescue plan and another forthcoming infrastructure proposal will likely find approval among Fed officials.

“The way that the Fed views it, more stimulus mitigates downside risk,” McBride says.

Chairman Jerome Powell at the post-meeting press conference is bound to emphasize the importance of fiscal stimulus in the ongoing recovery, although he’ll avoid commenting on the specifics.

“The ball right now is in the fiscal policy’s court, not in the monetary policy court,” Rick says.

What this means for you

With the economy at a critical juncture, now is an important time to keep your finances in check. Take advantage of low interest rates by paying off debt, particularly high-cost credit card borrowing. If you’re a homeowner, you should also consider refinancing, which has the potential to shave hundreds of dollars off your monthly payment, depending on where your interest rate stands.

If you’re shopping around for a loan right now, keep a careful watch on your credit score by paying all bills on time and utilizing no more than 30 percent of your available credit line. Most lenders reserve the lowest rates for the borrowers that have the most attractive credit history.

Consumers waiting on a loan to close right now may want to think about checking in with their lender to see if they can utilize a rate lock. Such a move would potentially lock in your rate for 30 to 60 days and ensure that your borrowing costs don’t rise amid volatility in the Treasury market.

Take advantage of key forbearance programs if you’re struggling to keep a lid on your expenses. Biden extended a federal student loan forbearance and interest waiver program through September and another program for homeowners with a federally backed mortgage through March.

And just because savings rates are at all-time lows doesn’t mean you should be parking your funds elsewhere. An emergency fund, typically worth six to nine months’ of your expenses, is a crucial aspect of your financial portfolio. A January Bankrate survey found that fewer than 4 in 10 Americans could afford a $1,000 emergency expense with their savings, underscoring the rocky state of U.S. households during the worst downturn in generations.

“The fundamentals still apply,” McBride says. “Paying down debt and keeping a close eye on expenses are also important particularly in households with tight budgets.”

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