Fed governor cites ‘fog of uncertainty’ presented by surging virus; headwinds to economic recovery building

The “dense fog” of coronavirus-related uncertainty is shrouding the economic outlook, posing headwinds to an economic recovery for some time and calling for a sustained commitment to accommodation along with additional fiscal support from the federal government, a member of the Federal Reserve Board said Tuesday.

In remarks via webcast to a webinar sponsored by the National Association for Business Economics (NABE), Federal Reserve Board Gov. Lael Brainerd said downside risks predominate in the wake of the coronavirus crisis. However, even if those risks fail to materialize, she said, an economic recovery is still likely to face headwinds – and a second wave of the virus, which some expect to materialize this fall, would “magnify that challenge” to a recovery.

“Uncertainty will remain elevated as long as the pandemic hangs over the economy,” Brainerd said. “Even if the virus spread flattens, the recovery is likely to face headwinds from diminished activity and costly adjustments in some sectors, along with impaired incomes among many consumers and businesses.”

Brainerd acknowledged that the economy bottomed out in April, and came back in May and June. But the rebound was accompanied by a “sharp increase” in the virus spread in many areas, she said.

She said rolling flare-ups or a broad second wave of the virus could lead to widespread mandatory or voluntary social distancing. She asserted that could weigh on the pace of the recovery and could even signal a second dip in economic activity. “A broad second wave could re-ignite financial market volatility and market disruptions at a time of greater vulnerability,” the Fed governor said.

Brainerd singled out nonbank financial institutions, saying they could again come under pressure from the economic hit produced by the pandemic, “as they did in March.” She said some banks might pull back on lending if they face rising losses or weaker capital positions.

In addition, some high-frequency indicators tracked by Federal Reserve Board staff (including mobility data and employment in small businesses), she said, suggest that the strong pace of improvement in May and the first half of June may not be sustained.

The Fed governor also noted that the central bank is watching closely the “historically elevated levels of debt” the nonfinancial business sector held at the beginning of the year.

“Already this year, we have seen about $800 billion in downgrades of investment-grade debt and $55 billion in corporate defaults—a faster pace than in the initial months of the Global Financial Crisis” of a decade ago, she said. “Several measures of default probabilities are somewhat elevated. It remains vitally important to make our emergency credit facilities as broadly accessible as we can in order to avoid the costly insolvencies of otherwise viable employers and the associated hardship from permanent layoffs.”

She reminded the audience that the pandemic’s harm falls disproportionately on black and Hispanic families. “After finally seeing welcome progress narrowing the gaps in labor market outcomes by race and ethnicity in the late stage of the previous recovery, the COVID shock is inflicting a disproportionate share of job losses on African American and Hispanic workers,” she said. “According to the Current Population Survey, the number of employed persons fell by 14.2% from February to June among African Americans and by 13.4% among Hispanics—significantly worse than the 10.4% decline for the population overall.”

Federal Reserve Gov. Lael Brainard: Navigating Monetary Policy through the Fog of COVID