Fed will need to provide accommodation, Brainard says

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The Federal Reserve will have to change monetary policy from offering "stabilization" to "accommodation," according to Federal Reserve Governor Lael Brainard.

"With the recovery likely to face COVID-19-related headwinds for some time, in coming months, it will be important for monetary policy to pivot from stabilization to accommodation," she told the Brookings Institution Tuesday, according to prepared text released by the Fed. "As we move to the next phase of monetary policy, we will be guided by the Committee’s new goals and strategy statement."

The uncertainty related to the coronavirus pandemic causes downside risks, she noted. "The longer COVID-19-related uncertainty persists, the greater the risk of shuttered businesses and permanent layoffs in some sectors."

Although the disease will determine the future, "the magnitude and timing of further fiscal support is a key factor for the outlook," with "fiscal support ... essential to sustaining many families and businesses."

Additionally, with little room for the Fed to maneuver when rates are near zero, while “unemployment is elevated, and inflation is below target,” will likely lead to more frequent and longer stints at zero lower bound, she said. “The risk here is a downward spiral where the scope for cutting the interest rate gets compressed even further, the lower bound binds even more frequently, and it becomes increasingly difficult to move inflation expectations and inflation back up to target. The experience of some foreign central banks illustrates the challenges associated with such a downward spiral.”

"The near decade of inflation persistently short of 2% creates the risk that households and businesses come to expect inflation to run persistently below target and change their behavior in a way that fulfills that expectation, which greatly complicates the task of monetary policy," said Federal Reserve Governor Lael Brainard.

The Fed's average inflation target rule, Brainard said, is “appealing in theory,” but offers challenges in implementation and communication. “Analysis suggests it could take many years with a formal AIT rule to return the price level to target following a lowerbound episode, and a mechanical AIT rule is likely to become increasingly difficult to explain and implement as conditions change over time,” she said.

By missing its inflation target for so long, American may expect inflation to continually remain below 2% “and change their behavior in a way that fulfills that expectation, which greatly complicates the task of monetary policy,” Brainard said. “While inflation expectations are difficult to measure with precision, some market-based and survey-based indicators show signs of a downward drift.”

The Institute for Supply Management's manufacturing sector index climbed to 56.0% in August from 54.2% in July.

Economists polled by IFR Markets expected the index would rise to 54.5%.

“This figure indicates expansion in the overall economy for the fourth month in a row after a contraction in April, which ended a period of 131 consecutive months of growth,” said Timothy R. Fiore, chair of the ISM Manufacturing Business Survey Committee.

The new orders index gained to 67.6% from July’s 61.5%. Production edged higher to 63.3% from 62.1% the previous month.

The employment index rose to 46.4% from 44.3%. The prices index increased to 59.5% from 53.2%, while inventory dropped to 44.4% from 47.0% and customers’ inventories fell to 38.1% from 41.6% in July.

The backlog of orders Index grew to 54.6% from July’s 51.8%, while the supplier deliveries index was at 58.2%, higher than the 55.8% in July.

New export orders increased to 53.3% from 50.4% and imports increased to 55.6% from 53.1% last month.

“The ISM U.S. manufacturing sentiment index [is now at] a 21-month high and the increase in the index further above 50 indicates that manufacturing activity expanded at a faster rate in August,” said Roiana Reid, U.S. economist at Berenberg Capital Markets. “The details of the ISM manufacturing survey were broadly positive: eight of the 10 subindexes increased, and 15 of the 18 manufacturing industries reported growth, the most since March 2019.”

Construction spending
July construction spending gained 0.1% after a revised June 0.5% decrease, first reported as a 0.7% decline.

Economists estimated spending to increase 1.0%.

“This is the first construction spending increase since February,” said Scott Anderson, chief economist at Bank of the West.

Spending year-over-year is 0.1% lower than in July 2019.

Dallas Fed services survey
Texas service sector activity “held mostly steady in August after declining in July,” according to the Federal Reserve Bank of Dallas.

The current general business conditions index jumped way up to positive 4.7 in August from negative 26.7 in July, while at the company level, the index also grew to positive 5.6 from negative 15.8.

The outlook uncertainty index dropped to 5.7 from 29.4 the month before.

The revenue index climbed to positive 1.5 from negative 8.5, the employment index narrowed to negative 0.3 from negative 6.8 and the part-time employment index expanded to positive 0.1 from negative 11.5.

The hours worked index narrowed to negative 1.0 from negative 3.7, wages and benefits gained to 4.9 from 0.4 and input prices increased to 22.2 from 17.8.

Selling prices reversed to positive 4.4 from negative 5.9 and capital expenditures narrowed to negative 0.5 from negative 7.9.

Looking six months ahead, the general business activity outlook index and the company outlook index both turned positive. General business gained to positive 19.2 from negative 9.2, while the company outlook increased to positive 21.9 from negative 3.1.

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Monetary policy Lael Brainard Economic indicators Federal Reserve Inflation FOMC