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Fed likely to avoid surprises amid 2020 election, COVID-19 case surge

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Fed likely to avoid surprises amid 2020 election, COVID-19 case surge

The Federal Reserve is heading into its meeting this week with two big questions looming: what will the 2020 elections mean for fiscal stimulus, and how will the surge in COVID-19 cases affect the economic recovery?

With the answers to both likely unresolved for some time, analysts expect Fed officials to hold steady on policy at their post-election meetings Nov. 4 and 5 and to monitor how the economic outlook unfolds.

Unless markets panic this week, the Federal Open Market Committee will likely avoid taking "any action before the election uncertainty subsides," Philip Marey, senior U.S. strategist at Rabobank, wrote in a note to clients.

Fed officials will be sure to discuss policy changes they may opt for in the weeks ahead, including whether to adjust their current program of buying $80 billion in Treasury securities every month. But the Fed's bond-buying plans are likely to hinge partly upon how aggressive of a fiscal package lawmakers could settle on once the 2020 elections are over, which could take days to resolve given the surge in early voting this year.

"I think the Fed is going to punt on any major questions until they know what the landscape looks like," said Shannon Saccocia, chief investment officer at Boston Private, adding that Fed Chairman Jerome Powell will likely reiterate the importance of Congress approving more stimulus spending.

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The FOMC meeting comes days after new data showed U.S. GDP rising at an annual rate of 33.1% in the third quarter, a record gain but one that still left the U.S. economy short of its pre-pandemic levels. The unemployment rate has also quickly fallen to 7.9% from its peak of 14.7% in April, but analysts worry the initial pace of gains is slowing and note that the U.S. still has roughly 10.7 million fewer jobs today than in February.

Employers who were initially reluctant to permanently lay off workers may also change their minds as the COVID-19 pandemic stretches into 2021, said RiverFront Investment Group's Kevin Nicholson.

"It's going to be a much tougher road here going forward," he said.

The economic recovery has been particularly strong in the housing market, where low interest rates and increased demand helped lead to a 9.4% jump in existing home sales in September. Retail sales also surged by 1.9% in September, as mostly upbeat consumers continued to spend on a wide variety of goods.

But the economy is likely to see some "stalling out" in the weeks ahead, as the fiscal boost that Congress gave to consumers continues to fade, Saccocia said. She also noted that the recent surge in COVID-19 cases in the U.S. could lead to more localized lockdowns and perhaps make consumers more wary of engaging in economic activities.

"It's not going to be grinding to a standstill like we saw in March, but if ... you get a little bit of softness in that data, the markets are going to react to that," she said.

Stock markets took a more gloomy tone last week as investors prepared for that possibility, although equities were clawing out slight gains Nov. 2. The S&P 500 was up 0.86% to 3,284.97 as of 2:15 p.m. ET, although it remains below its recent peak of 3,465.39 on Oct. 23.

Bond yields have also ticked up in recent weeks, with 10-year Treasury yields settling at 0.88% on Oct. 30, up 20 basis points from Oct. 1. Analysts attribute much of the increase to markets pricing in a potential "blue wave," in which Democrats recapture the White House and Senate and opt for a larger stimulus program than Republicans might favor.

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Higher long-term yields could eventually become a source of concern for the Fed, given that it would drive up mortgage rates and other borrowing costs and therefore dampen spending.

If those increases continue and push 10-year yields beyond 1%, the Fed will likely try to bring them back down by shifting its current program of Treasury purchases toward longer-term securities, wrote Kathy Bostjancic, Oxford Economics' chief U.S. financial economist, in a note to clients. But the central bank will likely opt for a "wait-and-see approach" on that question as well as providing clearer guidance to markets on how long the current Treasury purchase program will continue, she wrote.

Any changes will likely have to wait until officials get more clarity on how large of a fiscal package could be coming from Congress, RiverFront Investment Group's Nicholson said. A blue wave, for example, could result in Democrats approving a multi-trillion-dollar spending package and increase the government's borrowing needs. That would push up bond yields and likely prompt the Fed to ramp up its Treasury purchases and absorb some of the increase in government debt.

"The Fed does not want interest rates to rise too quickly ... because right now the mortgage market has basically kept the economy going," Nicholson said.

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