Fed Watch: Look for taper, not a hike

09-14-2017

As Federal Reserve policymakers get set to meet, the term “taper” doesn’t seem to be inspiring fear in bond-land this time around. When the Fed last mentioned it, we got the disruptive “Taper Tantrum” of mid-2013, when bond yields spiked. But that was a different time and involved the reduction of bond purchases as part of quantitative easing (QE). The Federal Open Market Committee (FOMC) meeting Wednesday likely will announce more of a whittling: slowly shrinking its massive balance sheet by tapering reinvestments of maturing securities. Fed officials have given markets clear indication of this plan for very slow balance sheet reduction, with only the start date in question. That date likely is upon us and the slow reduction in holdings that will result should have little near-term market effect. That said, this step marks another phase of the long-run normalization of monetary policy that, over time, will reinforce higher market yields.

The Fed has been less forthcoming with information relating to the timing of the next rate hike. Inflation disappointment—PCE headline and core hovering around 1.5%—continues to make the Fed cautious, likely leading to a lower trajectory of Fed funds projections (the so-called “dot plot”) at the upcoming meeting. The next practical opportunity for another tightening is in December, but that month is now rife with complication, including the postponed budget deadline and related risk of a government shutdown. In the meantime, the markets will pay extra attention to inflation indicators and whether they open the door for another Fed move at year-end.