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The Federal Reserve is expected to have a lengthy discussion this week about slowing down the monthly bond purchases that are so important for financial markets.
But investors expecting clear answers about the crucial questions of when the tapering will start and the pace of any pullback will likely be disappointed, economists said.
Fresh concerns about global economic growth and the spread of the delta variant of the coronavirus have eased inflation concerns somewhat and taken some pressure off the Fed to be more forthcoming about its tapering plans, economists said.
“We expect chair Powell to stop short of signaling that tapering is imminent,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank, in an interview.
Vince Reinhart, Mellon’s chief economist, agreed. “I think Jay Powell has a somewhat easier time than you would have thought weeks ago. The concern about the delta variant has been associated with lessened concern about inflation and more concern about the global outlook. And so the drumbeat [for the Fed] to provide hard evidence they are on the way to slowing asset purchases will be a little less intense,” he said.
Mohamed El-Erian, chief economist adviser at Allianz, said that the most markets will hear next week is “some conditioning to expect tapering at the end of the year.”
The Fed will meet next Tuesday and Wednesday and issue a statement at the end of after the second day of its deliberations at 2 p.m. Powell will follow with a press conference at 2:30 p.m. Eastern time.
Since the pandemic hit, the Fed has kept its benchmark interest rate close to zero. When it was clear early last year that the economy was going to have to shut down, the Fed stepped in and bought trillions of dollars of government debt to settle financial markets. The central bank eventually slowed down the purchases last summer to a steady pace of $120 billion each month — consisting of $80 billion of Treasurys and $40 billion of mortgage-backed securities.
Last December, the central bank said only that it wouldn’t slow the purchases until “substantial” progress has been made toward the central bank’s goals of a healthy labor market and stable 2% inflation.
Monetary policy hawks on the Fed policy making committee downplay this requirement and want the central bank to start the process sooner rather than later.
But the majority on the Fed’s interest-rate committee, led by Powell, who told Congress last week that substantial progress “is still a ways off.”
In June, with the recession in the rear-view mirror and economic recovery underway with inflation picking up, the Fed finally started “talking about talking about” when to slow down these bond purchases.
Minutes of the Fed’s June meeting said Fed officials “generally judged that, as a matter of prudent planning, it was important to be well positioned to reduce the pace of asset purchases, if appropriate, in response to unexpected economic developments.”
As a result, at the meeting this coming week, economists think the Fed will do the planning and review a range of tapering scenarios such as whether to slow down MBS purchases at a faster pace than Treasurys, but no decisions are expected.
This is a feature, not a bug, of the Fed’s communication strategy, economists said, but analysts do agree that a lot depends on upcoming employment reports.
The earliest Powell might say something substantive about tapering, economists said, is at the end of August during the Fed’s summer retreat in Jackson Hole, Wyoming.
But many others think this is too soon for any announcement of tapering and are penciling in an announcement at the Sept. 21-21 FOMC meeting. Others see the Fed waiting until its meeting on Nov. 2-3 so they can gauge how the economy and labor marker respond after children return to in-person schooling in the fall.
Economists generally agree the Fed won’t raise its benchmark interest rate until after it has stopped monthly purchases entirely.
That should take about eight months, said Kathy Bostjancic, head U.S. financial market economist at Oxford Economics.
The big picture is that Fed monetary policy will remain easy until its benchmark rate has moved well above zero.
Underneath the Fed’s discussion next week is growing unease among many economists about the Fed’s “flexible average-inflation targeting’” strategy that was adopted last year. As part of this new strategy, the Fed promised to wait for actual data and not move on forecasts.
That seemed like an appropriate strategy when inflation was low but inflation has roared back this year and is now well above the 2% target. The consumer price index jumped to a 5.4% pace over the past 12 months ending in June.
Economists are having trouble squaring how the central bank will react to this higher inflation given this new approach. Powell says higher inflation is “transitory” but there is a growing sense that it could stick around.
The bottom line next week will be that the Fed is moving to take its foot off the gas, said Ed Hyman, chairman of Evercore ISI.
“They’re moving and they will keep moving,” he said, in an interview on Bloomberg Radio. Whether the tapering starts in December or January doesn’t make a big difference in the big picture, he added.
And whether inflation will force them to move at a faster pace than is currently anticipated — that is a question for another day.
El-Erian insists the Fed will ultimately will have to move at a quicker pace toward tightening.
“They are going to try to condition the market for a very gradual reduction to begin with, and then reality will sink in,” El-Erian said.
“This inflation episode is very different from what we’ve had for decades now,” he said.
El-Erian said he felt his prediction was on par with his 2009 call for a “new normal” or years of dispiriting low global economic growth in the wake of the global financial crisis.
U.S. stocks
DJIA,
SPX,
were set to open lower on Monday on a pickup in bilateral tensions with China.
The yield on the 10-year Treasury note
TMUBMUSD10Y,
fell to 1.255% on Monday from 1.286% last week.
