How Will the Fed Deal With Its Latest Dilemma?
It doesn’t want to spur market volatility, but it doesn’t want to fuel a moral hazard, either.
Nothing reassures investors more than the support of an infinite central bank balance sheet.
Photographer: Jeenah Moon/Bloomberg
Among the three systemically important central banks holding policy meetings this week — the Bank of Japan, the European Central Bank and the Federal Reserve — the Fed is least likely to announce new policy measures. Yet its assessment of the economic outlook and, more important, its guidance on future policy measures will go a long way in determining the performance of financial markets.
Since its three unscheduled meetings in March, the Fed has calmed markets with its extraordinary interventions despite a continued sharp deterioration in the economy and employment prospects. Its emergency measures have reduced the risk of market malfunctions, restored liquidity and opened up key segments of the corporate bond market to significant new issuance by both investment-grade and high-yield companies. This has come against the background of a severe decline in employment, with more than 26 million people losing their jobs despite substantial fiscal support. Most observers expect this collapse in consumption, along with corporate investment and trade, to cause a record contraction in second-quarter gross domestic product.