Fed's journey to taper could start later this year
Policymakers likely want to see a few more developments before announcing it.
Bottom line Federal Reserve Chair Jerome Powell successfully threaded the needle during his keynote speech at the Fed’s annual monetary policy symposium in Jackson Hole, Wyo., this morning. He said the labor market is recovering strongly, inflation is running close to the Fed’s price-stability goals, and it could be appropriate to start reducing the pace of asset purchases later this year. I believe the Fed is on pace to make that announcement at the November Federal Open Market Committee (FOMC) meeting.
Importantly, he also emphasized that the coming reduction in asset purchases was not intended to signal an imminent interest-rate liftoff. Financial markets applauded Powell’s speech, as the S&P 500 hit another record high earlier today at 4,512, benchmark 10-year Treasury yields slipped from 1.36% to 1.31%, and the VIX declined from 19 to 16.
Why is Jackson Hole important? This prestigious symposium, started by the Kansas City Federal Reserve in 1978, routinely draws top central bankers from around the world to discuss important global economic issues (For the second consecutive year, the conference was conducted remotely due to the coronavirus). The Fed chair typically delivers a high-profile keynote speech to discuss important monetary-policy thoughts. This year’s theme was “Macroeconomic Policy in an Uneven Economy.”
No silver bullet Powell’s keynote speech was not a smoking gun on the direction of monetary policy. Rather, it was another in a series of strategically placed bread crumbs methodically doled out in recent months to mentally prepare investors for an eventual and inevitable tapering of bond purchases, in the hopes of avoiding the dreaded “Taper Tantrum” of 2013.
- June 2 The Fed announced it will liquidate its $13.7 billion in exchange-traded funds and direct corporate bond holdings by the end of 2021. It had authorized this emergency-lending vehicle in March 2020 with $250 billion in capacity.
- June 16-17 FOMC meeting The Fed radically changed its Summary of Economic Projection (SEP) to reflect stronger economic growth and faster inflation, along with an accelerated timeline to withdraw accommodation.
- July 13-14 semiannual Humphrey-Hawkins meetings Powell spoke before Congress, acknowledging that inflation is running hotter and more sustainably than the Fed had expected.
- July 27-28 FOMC meeting The Fed reviewed formal tapering policy options, presented by its economic staff.
- August 26-28 Jackson Hole symposium Powell in his keynote speech made the case for tapering asset purchases later this year. But there’s no timeline, per se, merely a pledge for the Fed to be data dependent, although he remains “all in” that the inflationary pressures will eventually recede.
- Sept. 21-22 FOMC meeting Another quarterly SEP meeting, at which we believe that the Fed will raise inflation forecasts again, as nominal and core inflation (PPI, CPI & PCE) continue to rise, despite the end of “procedural base effects,” which rolled off three months ago. This morning, for example, the core PCE index (the Fed’s preferred measure of inflation) rose 3.6% year-over-year in each of June and July (a 30-year high) and well above the Fed’s 2% target.
In our view, this sets the table for Fed to announce their taper plans at the next FOMC meeting on Nov. 2-3. Why the delay? We think the Fed wants to buy time to gauge the progress on three critically important developments:
- The delta variant appears to be peaking now in about one-third of U.S. states, and we appear to be following the U.K. with a lag of a month or two. So, will the current delta rollover in those states prove sustainable, and will delta also rollover in the other remaining states? Will another variant (perhaps lambda) replace delta as our next big Covid-19 concern? Will the vaccinations still be efficacious against these new variants? We will likely have a much better view of this overall health-care picture in early November than in mid-September.
- The Federal unemployment bonus of $300 per week ends Sept. 6 for 24 states. It has already concluded in June/July in 26 states. The September jobs report will be released on Friday, Oct. 8. Will the end of these Federal benefits hurt or help the labor market? We think it will help, by encouraging unemployed workers to re-enter the labor market and take one of the record 10 million open jobs, according to the most recent June JOLTS report. But we don’t know for sure, and we think the Fed would like to see those September job numbers.
- Fiscal policy crossroads as Speaker Pelosi has set a Sept. 27 date for a vote on the popular bipartisan $1.2 trillion hard infrastructure bill. But we don’t know if the contentious $5.5 trillion social-spending bill will pass in the interim. That second bill, in our view, is too large relative to the economic cycle, it permanently expands entitlement spending, and it will be paid for with a huge increase in both federal debt and tax increases on corporations and successful individuals. If this bill passes as proposed, it will likely be a drag on economic growth in 2022 and beyond. We believe that the Fed would like to know the details of that fiscal policy drag, so it can adjust their monetary policy accordingly.
MBS first? We think the Fed will begin to taper its $120 billion per month bond-buying program ($80 billion in Treasuries, $40 billion in mortgage-backed securities) in late 2021 through mid-2022, with MBS first, and then Treasuries later. That sets the table for an eventual exit from the Fed’s zero interest-rate policy (ZIRP) starting in early 2023, which would be a year earlier than the Fed has discussed. Based upon what we think we know right now, the Fed might increase the fed funds rate with perhaps two quarter-point hikes over the course of 2023.
Possible leadership transition? Another important overlay to support continued monetary policy accommodation for now is that Powell’s term as Fed chair expires at the end of January 2022. It appears he would like to be reappointed, but Biden hasn’t decided yet—and we believe the president has amassed a list of perhaps nine other eligible candidates. So, Powell might remain accommodative for now, as we expect that Biden will declare his intentions on re-nominating the Chair before the end of October, so the Senate can hold hearings and confirm the chair-designate during November.