WASHINGTON — Federal Reserve officials warned on Friday that the U.S. economic outlook remained wildly uncertain, as parts of the country see a new surge in coronavirus infections.
“So far, in the United States efforts to contain the virus have not been particularly successful,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a speech on Friday. With the spread of the disease continuing “and the acceleration of new cases in many states, I expect the economic rebound in the second half of the year to be less than was hoped for at the outset of the pandemic.”
But while the downturn could persist — or worsen — the central bank’s vice chair for supervision, Randal K. Quarles, said the Fed would determine capital requirements — essentially the financial cushions that banks must keep to withstand losses — based on economic scenarios developed before the pandemic took hold. While the Fed is testing the strength of banks against multiple dire scenarios that reflect how the virus might play out, the central bank will not publish bank-specific results.
“We don’t know about the pace of reopening, how consumers will behave or the prospects for a new round of containment,” Mr. Quarles said. “There’s probably never been more uncertainty about the economic outlook.”
Given the serious risks, the Fed’s annual “stress tests,” the results of which will be released next week, will include three sensitivity analysis scenarios. These would look at how the banking system would fare in the case of a V-shaped recovery, in which output and employment bounce back quickly; a U-shaped rebound, in which jobs and growth take a long time to recover; or a W-shaped trajectory, in which a second wave of the coronavirus forces activity to collapse again, Mr. Quarles said.
Those scenarios could influence whether individual banks are allowed to pay out shareholder dividends down the road. But they will not result in different capital requirements for the supervised banks, even if the Fed finds a bank would not be able to withstand losses and continue to lend under one of the more dramatic scenarios.
The Fed will “provide results aggregated across banks that will compare how the banking system as a whole would fare under the three distinct views of the future,” Mr. Quarles said. He noted that given time constraints, the central bank did not pre-publish the three scenarios or run full stress tests with them.
Mr. Quarles noted that the Fed had generally seen “value” in “not increasing capital requirements under stress and thus exacerbating a downturn” when it approached stress testing.
Even so, the decisions to stick with the pre-pandemic scenario, and to release the sensitivity tests only in aggregate, struck some as potentially irresponsible. Banks are expected to play a critical role in the downturn, and there is a complete lack of clarity about how the economy will fare over the next several months.
The Fed’s originally published scenario in February — upon which the “stress capital buffer” requirement will be based — is similar in “overall severity” to the most optimistic, V-shaped sensitivity analysis, Mr. Quarles said.
“You’re likely to get a smaller stress capital buffer using the February scenario,” said Jeremy Kress, a former Fed regulator who is now at the University of Michigan. He also said the fact that bank-by-bank results from the scenarios would not be released “makes me nervous about what they found.”
Banks went into this crisis with much higher levels of capital than they had heading into the 2007-9 downturn, and in better positions than many of their counterparts overseas. Despite that, the pandemic is an economic emergency without precedent, making it difficult to predict exactly how the financial system will fare.
The Fed has taken a number of actions to ensure that lending continues and credit does not become prohibitively expensive, relaxing some regulations while rolling out a variety of emergency programs, including several that buy loans to qualifying small and medium-size businesses from bank balance sheets.
Even so, central bank officials have repeatedly warned that they and Congress might need to do more to make sure the economy can recover as huge risks persist.
“Lives and livelihoods have been lost, and uncertainty looms large,” the Fed chair, Jerome H. Powell, said in remarks prepared for delivery Friday afternoon. “We will make our way back from this, but it will take time and work,” he said, noting that “the path ahead is likely to be challenging.”
Mr. Rosengren was even starker in his warnings. He pointed out that coronavirus cases in South Carolina and Florida were rising, and offered a glum outlook for unemployment, which he said was likely to remain “in double digits” through 2020. It stood at 13.3 percent in May, higher than at any point in the Great Recession.
While May’s employment report was better than expected, Mr. Rosengren said that might have stemmed from states reopening earlier than epidemiologists had recommended.
“This lack of containment could ultimately lead to a need for more prolonged shutdowns, which result in reduced consumption and investment, and higher unemployment,” he said.
Published at Fri, 19 Jun 2020 22:07:45 +0000-‘There’s Probably Never Been More Uncertainty,’ Fed Official Warns