Taper is on; rate hikes TBD
The Fed announced it will cut the pace of its asset purchases, but not on a preordained path.
Federal Reserve Chair Jerome Powell seems to have learned his lesson. Nearly three years ago, when the Fed was in the midst of unwinding its balance sheet after years of quantitative easing, he commented that the process was “on autopilot.” That roiled the markets, which took it that the Fed would not be attentive to changes in economic data. Powell and the Federal Open Market Committee (FOMC) made clear today that with the onset of tapering—slowing the pace of its current asset purchase program—policymakers will be flexible.
In its post-meeting statement that cited the strengthening economy, the FOMC announced it will trim the amount of its monthly asset purchases by $15 billion per month, split between $10 billion in Treasuries and $5 billion in agency mortgage-backed securities (MBS) beginning in November. This was exactly what the markets had expected and already priced in. But in a nod to uncertainty in the outlook for inflation, GDP and Covid-19, the Fed stated that the pace of tapering could be adjusted “if warranted by changes in the economic outlook.”
The markets initially interpreted that phrase hawkishly. Interest rates rose a few basis points on the presumption that tapering was not on a preset, immutable path, and that if inflation doesn’t decelerate the Fed may increase the amount in order to begin raising the fed funds rate sooner. That is at the heart of the matter. Powell stressed again that reducing asset purchases was in no way related to the decision to begin hiking rates, to which he ascribed a higher bar. The pace of the cutback is something of a proxy for when rate liftoff will occur, with the market saying that will be mid-2022.
The stock market seemed to be relieved that the FOMC kept its language regarding the “transitory” nature of inflation. But the Fed hedged its bet by adding that the factors causing elevated inflation readings are “expected” to be transitory. Had the Fed not at least hinted inflation may show some persistence, it would have run the risk of seeming to fall behind the inflation curve. Powell parsed this in his press conference, saying that transitory doesn’t necessarily mean short-term but “not having permanently higher prices.” Semantics perhaps, but in any case, the Fed continues to cheerlead “Team Transitory.” It is trying to thread the needle between projecting confidence price pressures will recede and giving investors confidence it will squash inflation if it persists.