Fed Hits the Gas on Tapering
At the conclusion of its meeting today, the Fed announced it will be doubling its tapering pace to $30B/month starting in January, circling a completion date of mid-March for QE. The Fed had left itself an opening to adjust its pace at the November meeting and Powell and crew took advantage by hitting the gas here.
When asked why the Fed doesn’t just abolish its asset purchasing in one go. He responded saying the Fed chooses to take a “methodical approach” in its strategy as “markets are sensitive” to such changes (i.e. Taper Tantrum).
In fact, the Fed doesn’t see the act of tapering to be nearly as important as giving markets a heads up on tapering. “When we communicate what we’re going to do, markets move immediately… financial conditions change on the expectation of things happening,” a not-so-subtle acknowledgment of the Fed’s forward guidance power.
Now that tapering is coming to an end in March, questions on balance sheet roll off inevitably crop up. Powell clearly kicked the can on this one by stating, “We haven’t made any decisions at all about when runoff would start”, but that it will be discussed in coming meetings.
Takeaway – The Fed did as expected, not much else to say here other than interest rate hikes are on the table starting in March.
“Nobody knows where the economy will be in 3 years.” Powell led off with this in his first question, clearly stating that the FOMC’s projections are not gospel. It’s no surprise considering the Fed upshifted their rate projections significantly with the dot plot now showing a median Fed Funds of 0.9% in 2022 and 1.6% in 2023, a projected three rate hikes each year. Long-term Fed Funds stayed unchanged at 2.5%.
Although this was a massive swing in the dots, market reactions were somewhat muted as markets have been projecting at least two hikes in 2022 for the past couple of months. Powell made sure to address this by saying inflation data received following the November meeting prompted to Fed to immediately adjust its rate projections for next year, they just had to wait until now to release it.
Takeaway – The Fed finally caught up with markets on interest rate projections, but the timing of these hikes remains to be seen as the Fed has yet to meet its full employment goals
Powel awkwardly admitted that the Fed has (more than) achieved its inflation goals. The decision to double the pace of tapering was clearly made in response to the flood of historic inflation data as Powell himself admitted.
The word transitory has been officially retired and made no appearance in the press release. Powell did defend the Fed’s projections earlier this year and argued the Fed is doing its best to “adjust its framework” to new data.
Powell still sees supply chains as the biggest contributor to inflation issues and refused to opine on the impact fiscal stimulus has had, “It’s not the Fed’s job, we aren’t the CBO…We take fiscal policy as it arrives at the front door”.
When asked about wage inflation, Powell remarked, “Thus far, wage growth has not been a major contributor to the elevated levels of inflation” but did admit the Fed is “attentive to the risks”.
Takeaway – Although the Fed was behind the curve on inflation, it’s okay because they knew they were behind the curve. Supply chains continue to be the issue and wage inflation is being monitored appropriately.
Since the Fed’s inflation goals have been met, labor is now the clear driver in determining the Fed’s policy. The Fed is rapidly approaching it’s “maximum employment” goal, at least by past standards. Powell was careful not to providing a quantitative qualifier for max employment for this exact reason.
Additionally, Powell acknowledged that the labor market has undergone a fundamental change due to Covid. Although the Fed became more optimistic in its 2022 unemployment projection, adjusting down from 4.8% to 4.3%, participation remains a problem.
Takeaway – As we said last meeting, fully employment will dictate rate hikes going forward.
Markets were vindicated in their projections of two rate hikes in 2022, with the Fed’s projections even exceeding the consensus forecasts.
2T unch at 0.66%
10T up 1bp to 1.45%
Equity markets responded positively with most indexes higher following the conference.