Inflationary risk and the delta variant of the coronavirus will be front and center at next week’s meeting of the Federal Open Market Committee, while policy changes will take a back seat.
The primary takeaways of the meeting, should there actually be anything other than a reaffirmation of the status quo, will be the inclusion of policymakers noting the news around rising inflation. We expect the FOMC policy statement will include the observation that inflation has increased “notably” even as the economy has strengthened.
Should the Federal Reserve mention the delta variant in the statement or should Chairman Jerome Powell go out of his way to identify it as a material risk to the economic outlook, we could see the market retest recent lows in the U.S. 10-year Treasury yield. In that case, market participants would adjust their expectations around the pace and magnitude of the widely expected tapering of the Fed’s $120 billion per month in asset purchases.
In some respects, the rise of the variants will present the Fed with the opportunity to postpone a more in-depth discussion around tapering that many market participants would like to see take place at the Kansas City Fed’s symposium on monetary policy at Jackson Hole, Wyo., next month.
We do not expect any change in the policy rate; technical changes to interest on excess reserves or the overnight reverse repurchase rate; or any changes to the forward guidance. Since there will be no Summary of Economic Projections issued at this meeting, there will be no update on the dot plot or implied rate forecast.
Powell’s recent congressional testimony increased expectations that the central bank may choose to introduce an asymmetrical policy bias around inflationary risks.
That is, it would adopt a more hawkish stance on its preparation to adjust the pace of asset purchases, its forward guidance or the federal funds rate. But with the rise of the coronavirus variants,
Powell has a ready-made reason to wait until the September meeting at the earliest to introduce such an asymmetric policy bias and focus on accommodative policy in support of financial conditions.
Labor market conditions are not aligned with the Fed’s target on maximum sustainable employment and overall employment is still roughly 6.7 million jobs short of the pre-pandemic level. The committee will continue to note that it will keep the policy rate at zero and asset purchases where they are until there has been “substantial further progress” toward the central bank’s goals.
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