Fed on tiptoe towards reduction next week

The Federal Reserve is expected to have a long discussion next week about slowing monthly bond purchases that are so important to financial markets.

But investors waiting for clear answers on the crucial questions of when to start the reduction and the pace of any withdrawals are likely to be disappointed, economists said.

New concerns about global economic growth and the spread of the delta variant of the coronavirus have eased inflation concerns somewhat and put pressure on the Fed to be more open about its reduction plans, said economists.

“We expect President Powell to stop signaling that the cut is imminent,” Matthew Luzzetti, chief US economist at Deutsche Bank, said in an interview.

Vince Reinhart, Mellon’s chief economist, agreed.

“I think Jay Powell is having a little easier time than you might have thought weeks ago. Concern over the delta variant has been associated with less worry about inflation and greater concern about the global outlook. And so the drumbeat [for the Fed] providing tangible evidence that they are about to slow down asset purchases will be a little less intense, ”he said.

Mohamed El-Erian, chief economist adviser at Allianz, said most markets will hear next week is “some conditioning to expect a decline at the end of the year.”

The Fed will meet next Tuesday and Wednesday and issue a statement after the second day of its deliberations at 2 p.m. Powell will follow with a press conference at 2:30 p.m. EST.

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 billions of dollars in government debt to settle financial markets. The central bank finally slowed purchases last summer to a steady rate of $ 120 billion per month, comprising $ 80 billion in treasury bills and $ 40 billion in mortgage-backed securities.

Last December, the central bank only said it would not slow down purchases until “substantial” progress was made towards the central bank’s goals of a healthy labor market and inflation. stable at 2%.

The monetary policy hawks on the Fed’s policy-making committee play down this demand and want the central bank to start the process as soon as possible.

But the majority of the Fed’s interest rate committee, led by Powell, which told Congress last week that substantial progress “is still a long way off.”

In June, with the recession in the rearview mirror and the economic recovery underway with the inflation picking up, the Fed finally started “talking talk” about when to slow down these bond purchases.

The June Fed meeting minutes stated that Fed officials “generally felt that, in prudent planning, it was important to be in a good position to reduce the pace of purchases of assets, if any, in response to unexpected economic developments “.

As a result, at next week’s meeting, economists believe the Fed will do the planning and look at a range of downsizing scenarios, such as slowing purchases of MBS at a faster pace than Treasuries, but no decision is expected.

This is a feature, not a bug, of the Fed’s communications strategy, economists said, but analysts agree a lot depends on upcoming jobs reports.

According to economists, the first Powell could say something substantial about tapering, which is at the end of August during the Fed’s summer retreat in Jackson Hole, Wyoming.

But many others believe it’s too early for a tapering announcement and are considering an announcement at the FOMC meeting on September 21-21. Others see the Fed waiting for its Nov. 2-3 meeting so they can gauge the reaction of the economy and the job market after kids return to school in person in the fall.

Economists generally agree that the Fed will not increase its benchmark interest rate until it completely stops monthly buying.

It should take about eight months, said Kathy Bostjancic, chief US financial markets economist at Oxford Economics.

The big picture is that the Fed’s monetary policy will remain loose until its benchmark rate has risen well above zero.

Under the Fed’s discussion next week, growing unease among many economists about the Fed’s “flexible targeting of average inflation” strategy that was adopted last year. As part of this new strategy, the Fed has promised to wait for the actual data and not to advance on the forecasts.

It 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 has jumped at a rate of 5.4% over the past 12 months ending in June.

Economists are struggling to determine how the central bank will react to this higher inflation given this new approach. Powell says higher inflation is “transient,” but there is a growing sense that it could persist.

The bottom line next week will be for the Fed to step back on gas, said Ed Hyman, chairman of Evercore ISI.

“They are moving and they will keep moving,” he said in an interview with Bloomberg Radio. Whether the tapering starts in December or January doesn’t make a big difference overall, he added.

And whether inflation will force them to move at a faster rate than currently expected, that’s a question for another day.

El-Erian insists the Fed will eventually have to step up the tightening.

“They’re going to try to condition the market for a very gradual cut to start with, and then reality will sink in,” El-Erian said.

“This episode of inflation is very different from what we have known for decades,” he said.

El-Erian said he felt his prediction was on par with his 2009 call for a “new normal” or years of disheartening global economic growth following the global financial crisis.

US DJIA equities,
+ 0.68%

+ 1.01%
were higher for the fourth day in a row after passing out on Monday amid concerns about the spread of the delta variant of the coronavirus.

The yield of the 10-year Treasury bill TMUBMUSD10Y,
fell to just under 1.3% after falling to 1.17% earlier in the week.

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