Fed upgrades expectations for pandemic-hit economy

The Federal Reserve said Wednesday that the economy will shrink by 3.7% this year — a rosier outlook than the 6.5% contraction initially projected in June.

Why it matters: The economy is still wrecked by the coronavirus pandemic, but has rebounded faster than some anticipated. Signs still suggest the recovery could stall out. The August unemployment rate is already lower than where the Fed, in June, said it would be by year-end.

• The Fed's fresh outlook sees the unemployment rate at 7.6%, lower than the 9.6% it saw three months ago.
• "For the last 60 days or so, the economy has recovered faster than expected. That may continue or not, we just don’t know," Fed chair Jerome Powell said in a news conference Wednesday.

Between the lines: The projections came alongside the Fed's closely watched policy statement, which said it expects to keep interest rates near zero until the labor market improves. It also said the Fed won't move on rates until inflation rises to 2% and is on track to "moderately exceed" that level for a period of time.

Of note: Two Fed officials dissented against the statement.

• Dallas Fed President Robert Kaplan wants the central bank to be more flexible with its interest rate setting path after the economy recovers and prices rise.
• Minneapolis Fed President Neel Kashkari says the Fed should indicate that it won't move on interest rates until inflation reaches 2% "on a sustained basis."

Catch up quick: The Fed said last month it's willing to allow prices to rise above its longtime 2% target for a period without raising rates to head it off.

• It was a massive shift in its inflation strategy. What it didn't specify was how long it'd be willing to let inflation drift higher — or how high it could go before the Fed was tempted to pump the brakes on the economy.
• "We're resisting the urge to create a rule or formula here," Powell said.

What they're saying: Powell said more fiscal support will "likely be needed." He added that both the Fed and private economic forecasters have another stimulus package baked into their forecasts. It's just a matter of "when and how much and what will be the contents," Powell said of expected action by Congress.

• Democrats and Republicans are deadlocked on negotiations for a stimulus deal.
• Powell laid out the worst case scenario if no additional stimulus comes: The unemployed will be unable to find work in sectors hit by the pandemic, which will show up in economic activity, evictions and foreclosures. These are "[t]hings that will scar the economy," Powell said.

What to watch: Powell indicated that the Fed will "be making some changes," to make its Main Street Lending Program more "broadly available."

• The Fed swept in when the pandemic started to throttle the economy with its own economic support programs, but some have so far fallen flat.
• The Main Street Lending Program has distributed just 117 loans as of Sept. 2. In the meantime, only two entities have taken advantage of the Fed's municipal lending facility.