Next week’s meeting of the Federal Open Market Committee will focus on the Federal Reserve’s exit from its pandemic-era asset purchase program that has sent its balance sheet above $8.5 trillion.
Expect the Fed to keep its policy rate in a range between zero and 25 basis points and not make any changes to interest paid on excess reserves.
We expect that the Fed will announce plans to reduce its monthly monetary accommodation of $140 billion in asset purchases by $15 billion a month—$10 billion in Treasury bonds and $5 billion in mortgage-backed securities. We expect it will start in December and run through the end of next June, when the Fed’s balance sheet will most likely have surpassed $9 trillion.
Away from the tapering discussion, the Fed will keep its policy rate in a range between zero and 25 basis points and not make any changes to interest paid on excess reserves.
We expect little change to the formal statement apart from the tapering start date and operational details. There will be no update to the Fed’s forecast at this meeting.
One can expect Fed Chairman Jerome Powell to use his news conference on Wednesday to reiterate that tapering is not tightening; the market has already moved aggressively to price in two full rate hikes by the end of next year.
Any reduction in the size of the Fed’s balance sheet is years away.
Raising rates on that schedule would be quite a bit quicker than the roughly one-year gap between the end of Fed asset purchases and the eventual rate hike that occurred in the last business cycle. Any reduction in the size of the balance sheet is years away. Our call is that the first rate hike will not occur until March 2023.
With Powell’s reappointment as Fed chairman hanging in the balance, we think that his news conference will serve as a barometer of his credibility within the market and across the policymaking spectrum.
On the margin, if one observes a pulling back on rate-hike expectations after the FOMC releases its statement and after Powell’s news conference, then that would imply that the market believes Powell will most likely be reappointed.
Ironically, if Powell is not reappointed, then the naming of Lael Brainard, who is far more dovish on policy and tougher on bank regulation than Powell, would likely spur a more mixed market reaction.
The Fed’s intent to begin slowing its pace of monetary accommodation is a clear signal that the economy, despite slowing in the third quarter to 2% growth, has met the “substantial further progress” test on reaching full employment that it has outlined in its communications.
While the core personal consumption expenditures index—its preferred policy variable—sits at 3.6%, the labor market is not at what the Fed might define as full employment at a 4% unemployment rate.
Should snarled global supply chains continue to wreak havoc with domestic growth, the Fed has a ready-made bridge to pause or delay the pace of its exit in the coming months.
We anticipate that Powell will again use his news conference to reiterate his view that the bar for a rate hike will remain elevated. In our estimation, market participants pricing in a rate hike next October are getting a bit ahead of themselves.
The pace of job growth would have to significantly accelerate for the Fed to be confident in pulling forward such a policy shift. The most recent pace of job growth implies a nearly two-year journey back to full employment.