Recently, data compiled by Goldman Sachs showed that financial conditions in the US were the loosest in 25 years.
The index dates back to 1990 and takes into account the value of the dollar and interest rates. Last week, the index reached its loosest level on record. It was undoubtedly driven by the Federal Reserve and the U.S. Congress, whose unprecedented support for the economy helped fuel a boom in U.S. financial markets.
Easier financial conditions are good for growth in the short term because they encourage businesses and consumers to borrow and spend. Economists at Goldman Sachs, led by Jan Hatzius, forecast US GDP growth of 5.3 per cent in 2021, “well above consensus expectations”, although this is driven more by the improved outlook for the epidemic than by a more accommodative non-financial environment.
But longer, looser lending carries risks that could inflate bubbles in equity and other asset prices and tempt borrowers to take on too much debt. In an article on Monday, Imf financial adviser Adrian Warned that policymakers “must weigh the pros and cons of additional stimulus now against increased risks to financial stability in the future.”
The US stock market has climbed to record highs in recent weeks and borrowing costs for US businesses and homebuyers remain at record lows. Some investors believe that with financial conditions back to pre-outbreak levels, the Fed can delay any strong action on Wednesday.
The reality, however, is that the pace seems far from over. A new stimulus bill is in the works in Congress, and the Federal Reserve is likely to keep pumping money out.
Is the Fed ready to keep pumping? Or extend the bond-buying program
The Federal Reserve will hold a two-day decision on interest rates this week and is expected to issue new guidance to expand its emergency bond-buying program, continuing to flood U.S. financial markets.
The positive market backdrop has certainly taken the pressure off the Fed to act urgently, but with the outbreak still severe, the Fed may have to change its guidelines.
At their meeting this week, Fed officials are widely expected to approve language that would continue the $120bn a month bond-buying programme launched at the start of the outbreak until there is a conditional recovery, according to senior economists and Fed watchers.
If agreed, the change would make it harder for the Fed to act sooner to scale back its bond purchases, thus cementing its easy monetary policy for years to come. Such a shift would complement the Fed’s commitment to keep interest rates near zero until inflation is expected to exceed 2 per cent and the economy is at full employment.
In addition, the Federal Open Market Committee will be forced to consider whether an asset purchase program is necessary for more aggressive monetary easing.
With a surge in COVID-19 cases, rising unemployment and confusion in Congress about the prospects for fiscal stimulus, some economists say the Fed may have to act now to fulfil its promise to do more to support the recovery if necessary. Last week, the ECB expanded its bond purchases and extended the maturity of its purchases after more shocks and constraints to the eurozone economy.
Julia Coronado, economist at Macropolicy Perspectives, said:
“In the US, the epidemic is getting worse, the economy continues to stall, and there is more evidence that the epidemic is having an impact on jobs. Meanwhile, US fiscal policy is up in the air – we don’t know what’s going to happen and I just don’t think it makes sense to come to the table empty-handed.”
In addition, the absence of a fiscal stimulus bill puts more pressure on the Fed to ease. Nick Maroutso, global head of debt at Janus Henderson, said:
“The less action there is on the fiscal side, the more inevitable it will be that the Fed will seek to act at its next meeting to support the markets, and that’s not going to go away anytime soon.”