Key Questions: What Did We Learn from the Fed Last Week?
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Expect a November Taper But No Hikes Until 2023.
There were no fireworks at the Jackson Hole symposium last week as Federal Open Market Committee (FOMC or Fed) Chairman Jerome Powell’s speech basically met expectations. He indicated that tapering its asset purchases is still likely this year but fell short of giving “advance notice.” Powell did give a nod to the downside risks posed by the COVID-19 Delta variant but downplayed them as short-lived.
More importantly, Powell drew a sharp distinction between tapering and tightening, saying that the former carries no signal for the latter and reminding us that the test for tightening is “substantially more stringent.” In other words, while liquidity might slowly come out of the market later this year or early next, interest rates don’t appear to be moving up any time soon.
The base case is a November tapering announcement, with the first $15.0 billion reduction effective December 1. Expect the Fed to effectively accelerate tapering from $15.0 billion/per meeting to $15.0 billion/month early next year, which would conclude the process in June.
Powell covered four main topics in his speech: tapering, Delta risks, interest rate hikes, and the economic outlook.
- On tapering: “My view is that the ’substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment,” he said. The reference to “clear progress” toward maximum employment is an upgrade from his earlier assessments and will likely be reflected in the September FOMC statement.
- On Delta risks: Although Powell acknowledged the spread of the Delta variant and signaled that it’s a risk to the taper timeline, he later went on to downplay it as a temporary setback. He noted that “while the Delta variant presents a near-term risk, the prospects are good for continued progress toward maximum employment.”
On interest rate hikes: One of the most critical takeaways from Powell’s speech is that the end of tapering, whenever it comes, will not be followed by immediate rate hikes. “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate lift off, for which we have articulated a different and substantially more stringent test.”
On the economic outlook: In a nutshell, Powell expects more employment and less inflation. His outlook for the labor market can be described as cautiously optimistic. “With vaccinations rising, schools reopening, and enhanced unemployment benefits ending, some factors that may be holding back job seekers are likely fading,” he noted.
Powell added: “While the Delta variant presents a near-term risk, the prospects are good for continued progress toward maximum employment.”
Interestingly, Powell went to great lengths in his speech to argue why inflation won’t be a long-term problem, strongly defending the transitory view. He gave five reasons why inflation is expected to subside, including the absence of broad-based inflation pressures so far, well-anchored inflation expectations, and the prevalence of global disinflation forces. These are Powell’s long-standing views and are not surprising, but he was clearly pushing back against the more hawkish voices on the FOMC who have been expressing concerns about inflation.
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