On July 29th, 2020 the federal reserve committed to keeping interest rates pinned to the zero bound and stated their expectation to maintain this position for years to come.
In his meeting with reporters to discuss fed policy, fed chair Powell stated, “We haven’t even thought about thinking when we plan to raise rates.” The FOMC statement explained why; “The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term. In light of these developments, the Committee decided to maintain the target range for the federal funds rate at 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” (1)
In a July 29th interview on Bloomberg, Ellen Zentner, Chief Economist of Morgan Stanley, said “In many areas U6 unemployment will remain about 20% range… especially due to ongoing weakness in hospitality and leisure, as well as layoffs by state and local government.” She continued “the level (of economic activity) is going to be lower, its getting back to a new normal… even after we repair, even after we have recovered, you are going to have a hit to potential growth, you are going to have a hit to labor force participation; we can easily come to the conclusion there will be some degree of permanent job loss.”
Why does this matter? While U3 is the official unemployment rate, U5 unemployment adds on discouraged workers and all other marginally attached workers. These people are still unemployed, but not in the job market for a variety of reasons. U6 unemployment adds on those workers who are part-time purely for economic reasons. U6 reflects the real degree to which the economy is constrained. (2)
On July 30th, 2020 the government announced new weekly unemployment claims of 1.43 million; this is an increase of 12,000 from last week and 126,000 more from two weeks previously. This reversal in the economic recovery has called into question expectations for a quick and modest recession. Continuing claims increase by 867,000 to 17 million in long term unemployed. (3)
While July’s unemployment rate is stated at 11.1%, U6 unemployment remains higher at 18.3%. Based on the rise in weekly unemployment numbers several economists expect those rates to move higher in the coming months.
Many of the jobs created since the 2008-2009 Great Recession have been part time service or Gig economy jobs. While some of these jobs were protected by the PPP loans, many small businesses have closed permanently. Many of these jobs did not provide benefits such as health insurance, disability insurance, life insurance or retirement plans. People working such jobs had increased responsibility to set up protection for themselves
Several studies prior to the current recession, including one by the Federal Reserve, showed the depth of the economic weakness even in 2019:
- Forty percent of American adults don’t have enough savings to cover a $400 emergency expense such as an unexpected medical bill, car problem or home repair.
- Forty-three percent of households can’t afford the basics to live, meaning they aren’t earning enough to cover the combined costs of housing, food, child care, health care, transportation and a cellphone, according to the United Way study. Researchers looked at the data by county to adjust for lower costs in some parts of the country.
- More than a quarter of adults skipped necessary medical care last year because they couldn’t afford it.
- Twenty-two percent of adults are not able to pay all their bills every month. (4)
This vulnerability became apparent as the COVID virus caused the shutdown of businesses nationwide and disrupted the cash flow for millions of Americans.
In March of 2020 Congress provided additional unemployment support to help people navigate the sudden change in economic conditions. In July of 2020 the continuation of such financial support has become a political football with the unemployed stuck in the middle. Several economists, including Ben Bernanke, have stated concern that in July 2020 the Unemployment support will expire, and the economy will suffer. (5)
Several years ago, when asked about the impact of unemployment on inflation, Alan Blinder, former Fed Vice chair and Princeton economics professor, said “For the past 20 years models like the Philips curve hasn’t worked.” He notes, “Models that used to predict unemployment, interest rates and economic growth don’t function anymore.” In many ways, the Fed is navigating an unknown landscape without the tools they relied upon generations to make good decisions. In the past five years the Fed has relied upon easy monetary policy to support the economy. (6)
In other news, on July 20th the ECB, announced they will increase asset purchases and provide fiscal support to member countries to help economic recovery. This will mean additional downward pressure on European bond yields, as well US treasuries and other global bonds. As central banks increase buying debt that is issued and coming onto the market it will create more pressure to move bond yields lower. (7)
So, what does this mean for retirees?
Retirees have traditionally relied upon interest income from bonds to generate stable, reliable income in retirement. An era of low rates has changed that dynamic and brought increased stress and insecurity. And based on central bank projections that dynamic is not expected to change any time soon.
As bond yields fall, the value of bonds increases. The impact on long dated bonds is even larger than on short term bonds. Bonds have traditionally been a store of value and a shock absorber for market volatility. A decade of Quantitative Easing has driven bond yields lower, but that environment is driving increased risk taking. Many retirees experience “Fear Of Missing Out” (FOMO) and chase higher returns in an increasingly unstable environment.
Several current and former Fed officials have warned about the increased risk taking in markets by investors.
Talk to your financial advisor about strategies that can be used to manage risk in this new environment. To discuss this issue and others related to retirement and building a sustainable financial future reach out to me at email@example.com
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Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 150 S. Warner Road, Suite 120, King of Prussia, PA 19406 (610)293-8300. Securities products and advisory services offered through PAS, member FINRA, SIPC. PAS is a wholly owned subsidiary of Guardian.
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