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Fed Shoots Down Notion of a V-Shaped Recovery

Mohamed A. El-Erian

(Bloomberg Opinion) -- In updating its projections for growth and unemployment on Wednesday, the Federal Reserve poured cold water on the notion that last week’s surprise jobs report signaled a sharp V-shaped recovery for the U.S. economy. In extending the timing and some of the scope of its notably dovish monetary policy signaling, the central bank also reinforced the deeply embedded market assumption that investors are well protected if they remain under the Fed’s policy umbrella. However, it left two questions open that are important for the future of the U.S. and global economies: How protected are assets on the periphery of the umbrella, and what does the notable disconnect between asset prices and the real economy mean for longer-term well-being?

The Fed’s latest economic forecasts suggest a 6.5% contraction in gross domestic product in 2020 that would take two years to reverse. The projection for the unemployment rate was also downbeat, with a 9.3% unemployment rate at the end of the year, or more than twice the level before the economic shock caused by the Covid-19 outbreak. With that, and with no fear of inflationary pressures anytime soon, the Fed extended its ultra-low (essentially zero) interest rate policy guidance through 2022 and signaled that it would stop what has been a slight tapering of some of its asset purchases in the last few weeks.

While consistent with many economists’ expectations of a check-mark-shaped recovery, the Fed’s economic projections are in sharp contrast to recent comments from the White House after Friday’s upside jobs surprise as well as some market participants’ embrace of the notion of a V-shaped recovery. They highlight the challenges for economic activity when it comes to bouncing back from a virtually universal sudden stop as well as the risks of longer-term scare. 

Most segments of the fixed-income market were comforted by confirmation of the dovish rate and quantitative easing signaling, including the junk bond index, which outperformed both the Dow Jones Industrial Average and the S&P 500 Index. That divergence was accentuated when, in the press conference after the release of the Fed’s statement, Chair Jerome Powell sidestepped questions seeking greater detail about the nature of future Fed support. This price behavior also highlighted market positioning going into this week’s Fed meeting. Many investors are assuming that securities that lie on the periphery of the protection umbrella provided by the Fed’s now more open-ended commitment to asset purchases would ultimately benefit from central bank support should severe economic pressures re-emerge. Those could include, for example, equities that carry a risk of capital impairment similar to low-quality high-yield bonds that are in the index the Fed has already been buying.

Powell also sidestepped longer-term concerns about the implication of the highly noticeable disconnect between Main Street and Wall Street. These concerns have come to the fore much more quickly than during the global financial crisis, and understandably so given the accumulated discomfort about the worsening inequalities in income, wealth and opportunity. They relate not only to de facto bringing growth and financial stability to today from the future, albeit both artificially fueled by leverage, but also to the impact of the widening risk of “zombification” of both companies and markets on productivity and growth. That means that in addition to nonviable companies being kept alive through the ample availability of debt at artificially low borrowing costs, markets would become incredibly distorted and therefore less effective at mobilizing and allocating resources efficiently and at supporting the crucial role of price signaling in a market-based economy.

The most important underlying message of Wednesday’s Fed meeting — the importance of a comprehensive policy approach that deals more effectively with productivity, employment, inequality and genuine financial stability — is also what would allow the inherent contradictions and unanswered questions to be resolved in a satisfactory and orderly fashion. For that, the Fed would need to hand off its policy leadership to other policy makers that have instruments better suited to deliver high and inclusive growth, sustainability and genuine financial stability — a handoff that has proven frustratingly elusive for a decade now, even as the stakes involved have grown significantly and now extend well beyond economic and financial issues.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."

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